Brief Advice needed for an Ignorant Youth


B

billw

Hi,
I'm not trying to make Usenet my CFP, but just want to get a brief
opinion. I do plan to hash out details with a real CFP later on.
Just wanna get in the right "ballpark"....if you will.

Situation:
- I have around $40,000 free cash now.
- Planning to buy a first home in about 3 years...but this is flexible
somewhat.
- 25 years old, with a steady job.
- I max out my 401k (~35K currently), and started a Roth IRA just a
month ago.

Question:
What should I do now with this $40,000 to prepare for a down payment,
given my 3 year timeline?

CD? Bonds? Or Index/Mutual Funds? I can take some risk, but maybe 3
years is too much a short term?

Thanks in advance.
bill
 
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C

Caroline

billw said:
Hi,
I'm not trying to make Usenet my CFP, but just want to get a brief
opinion.
Bill, for what it's worth, plenty of financially savvy people agree there's
nothing wrong with making Usenet, other internet sources, and your own brains as
your CFP.
I do plan to hash out details with a real CFP later on.
Just wanna get in the right "ballpark"....if you will.

Situation:
- I have around $40,000 free cash now.
- Planning to buy a first home in about 3 years...but this is flexible
somewhat.
- 25 years old, with a steady job.
- I max out my 401k (~35K currently), and started a Roth IRA just a
month ago.
Any credit card or auto loan debt?

Keep maxing out your Roth IRA. If you need the money for a house, you can
withdraw your contributions at any time (sans gains made while in the Roth IRA).
Question:
What should I do now with this $40,000 to prepare for a down payment,
given my 3 year timeline?

CD? Bonds? Or Index/Mutual Funds?
Search for the best rates on CDs at www.bankrate.com . Then call a discount
broker such as TD Waterhouse and see what they have for investment grade (that
is, low risk) corporate bonds. If the investment grade corporate bonds are
paying more, put around $20k into them and put the rest into CDs.

Or adjust the proportion according to your risk tolerance and the yield of each.

Also, if you're in a high tax bracket, investigate municipal bonds, as they
usually enjoy a nice federal tax break.
I can take some risk, but maybe 3
years is too much a short term?
Correct. If you put it into the stock market for three years, you're gambling.
 
J

John A. Weeks III

billw said:
- I have around $40,000 free cash now.
- Planning to buy a first home in about 3 years
What should I do now with this $40,000 to prepare for a down payment,
given my 3 year timeline?
This depends on how closely you know the date that you will need
the money, and what level of risk you are willing to take.

If you need to keep the money liquid and safe, available at any
time, then use a money market account.

If you can tie it up for months at a time, then CD's will give
you a better return, but you may have to way 30/60/90 days to
get at it.

If you just want to put it away for 3 years, and at that time
you may or may not buy a house, then pick up corporate bonds
that expire in 3 years. Buy only the top rated bonds.

If you want to take some risk and get some growth, then check
out no load index funds or exchange traded funds such as the
SP500 or Wilshire index funds. Problem is that you might hit
a down market, and not want to cash them out exactly in 3 years.
But the funds are liquid, so you can take your gains or losses
at any time.

Keep in mind that a safe place to put your money is also the
highest risk since you know for sure up front that you will
lose money in 3 years versus the cost of house. That is because
safe places are only earning 1% to 2% right now, but most houses
are going up in cost by 5% to 15% each year. Maybe you want to
buy that house right now? Even if it is a streach for you, go
visit a mortgage company (or your local banker) and see what
your options are for getting a mortgage, and how much it would
cost. You might be surprised at what your options are. In the
long run, it is better that you get the 5% to 15% annual gain
by owning a house, even if you have to buy something cheaper
now and trade up later on.

-john-
 
S

Sgt. Sausage

billw said:
Hi,
I'm not trying to make Usenet my CFP, but just want to get a brief
opinion. I do plan to hash out details with a real CFP later on.
Just wanna get in the right "ballpark"....if you will.

Situation:
- I have around $40,000 free cash now.
- Planning to buy a first home in about 3 years...but this is flexible
somewhat.
- 25 years old, with a steady job.
- I max out my 401k (~35K currently), and started a Roth IRA just a
month ago.

Question:
What should I do now with this $40,000 to prepare for a down payment,
given my 3 year timeline?

CD? Bonds? Or Index/Mutual Funds? I can take some risk, but maybe 3
years is too much a short term?

Thanks in advance.
bill
We (wife and I) keep our ThreeToFiveYearMoney in a series of
laddered CD's, with one coming due each quarter in case we're in
quick need of cash.

Seeing as how you're planning a lump sum withdrawal for your
downpayment, I wouldn't recommend this approach. From my
perspective, I'd probably go with a 3 yr CD, but *only* if you're
absolutely sure you won't need any of it for the next 3 years.
 
T

Tad Borek

billw said:
Situation:
- I have around $40,000 free cash now.
- Planning to buy a first home in about 3 years...but this is flexible
somewhat.
- 25 years old, with a steady job.
- I max out my 401k (~35K currently), and started a Roth IRA just a
month ago.

Question:
What should I do now with this $40,000 to prepare for a down payment,
given my 3 year timeline?

CD? Bonds? Or Index/Mutual Funds? I can take some risk, but maybe 3
years is too much a short term?
Bill,
First, you're off to a great start with $35k in retirement savings,
maxed-out 401k, and $40k in accessible savings at age 25. And kicking
money into a Roth is a great idea...unless the tax code changes that'll
be your only piece of tax-free money, really, and a lot of people think
tax rates have nowhere to go but up.

You don't say how much of the $40k you want to put into a house, whether
you have other money goals (school, travel, start a biz, 2CT rock, etc)
or how much else you think you might have saved by then. Most of the
down-payment part of it (the "3-year money") is best left in something
that won't lose value over that kind of time period. As others
mentioned, that limits you to things like money-market funds, savings
accounts, shorter-term CDs, and perhaps mutual funds that invest in
short-term bonds. Beyond that you'd be taking on some risk of losing money.

On the flip side, you might not need all of that $40k and/or you'll have
other money saved up by then. If so then only a portion of the $40k
needs to be invested so conservatively. And if you're OK with it, you
might want to take on some risk with part of the down-payment dollars,
even if it might not pay off. I find that when the goals are indefinite
("buy a house, not sure when, not sure how much") people are often more
willing to add some riskier investments. Contrast that to "I need $15k
for tuition by September" where you don't want that risk.

You could do a lot worse than sticking to bank CDs for the
most-accessible short-term dollars, and Vanguard index funds for
everything else. Depending on your expected time frame, funds could be
appropriate for part of the down payment. Keep in mind that "index
mutual funds" come in many varieties, and are only as risky as the
investments held by the fund (bonds, stocks, etc.). If you go to the
site www.vanguard.com you'll find plenty of information that classifies
their different funds by risk level. The funds are all no-load (no sales
charge) and have very low expenses. If you read up on them and get sold
on the Vanguard idea now, you could very well set yourself up for a
successful self-CFP route, at least with respect to investments.

Another alternative to CDs is "boring" US savings bonds, which you can
buy at a local bank or at http://www.publicdebt.treas.gov/. These have
the advantage of allowing you to defer tax on the interest, so your
money compounds faster. The I-bonds are inflation indexed, which is
nice. And of course nothing's as rock-solid as a US savings bond.

RE: other types of individual bonds...bond mutual funds, rather than
individual bonds, typically make a lot more sense for an investor with
just a few $10k to work with. Troll the archives of MIFP for the many
discussions on the topic, or just post a reply, if this topic is of
interest to you.

-Tad
 
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