Advice needed to make short-term investments in Taxable accounts

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gurusw
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Advice needed to make short-term investments in Taxable accounts

Postby gurusw » Sun Jun 18, 2017 1:14 pm

Hi,

I have stashed cash of around 100K+ strictly for house down payment. (This is not for emergency expenses or retirement). However there will still be 2-3 years of time before I buy a house.

I am wondering what kind of instruments I can invest in using the taxable accounts.

Initially I wanted to keep everything in tax-exempt bonds, but I am not sure if that's a good strategy. Even if that is a good strategy, I am having trouble selecting correct bond funds.

I have accounts with both Vanguard & Fidelity, and I am open to invest in any MF from these firms.

Thanks for your help.

retiredjg
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Re: Advice needed to make short-term investments in Taxable accounts

Postby retiredjg » Sun Jun 18, 2017 1:17 pm

Money for a downpayment probably should not be invested. It should be saved. Money market, high yield savings, CDs, maybe some in a short term bond fund. As for the bond fund, whether you use taxable or tax-exempt depends on your tax bracket.

Vanguard has better choices than Fidelity in bond funds, particularly tax-exempt.

livesoft
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Re: Advice needed to make short-term investments in Taxable accounts

Postby livesoft » Sun Jun 18, 2017 1:19 pm

I just invest in tax-efficient stock index funds in my taxable accounts no matter what the goal is. I don't worry about the risk and certainly don't worry about losing money. For instance, Vanguard Total Stock Market Index fund:

1. If it goes up in value, great! I pay either long-term capital gains tax or short-term cap gains tax when I sell (maybe), or ...
2. If it goes down in value, great! I get to tax-loss harvest and save on my taxes.
3. If it goes nowhere, then it is like a money market fund.

It's win, Win, WIN!

What are the consequences if such an investment would lose $5,000? $10,000? $20,000? Probably not a big deal because you would just change your house down payment goal or add money from your emergency fund.

Now cue the folks who will say that one should only invest this money in Certificates of Deposit and that one should take no risk! :)
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avalpert
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Re: Advice needed to make short-term investments in Taxable accounts

Postby avalpert » Sun Jun 18, 2017 1:25 pm

livesoft wrote:Now cue the folks who will say that one should only invest this money in Certificates of Deposit and that one should take no risk! :)

Right on cue:

What are the consequences if such an investment would lose $5,000? $10,000? $20,000? Probably not a big deal because you would just change your house down payment goal or add money from your emergency fund.


I highlighted the consequences for you since you didn't seem to catch them in your second sentence. So yes, there are obvious consequences and pretending otherwise is, again, just a way to rationalize what might be poor decisions without evaluating them appropriately.

The question the OP needs to ask himself is if the consequence of being able to put less down on the house (which means afford less of a house) is worth the risk to him. For some, they may be willing to take the chance of having to buy a smaller house in exchange for the potential upside - for other they won't be. But to not push them to see it in those terms does them a big disservice.

1. If it goes up in value, great! I pay either long-term capital gains tax or short-term cap gains tax when I sell (maybe), or ...
2. If it goes down in value, great! I get to tax-loss harvest and save on my taxes.
3. If it goes nowhere, then it is like a money market fund.

It's win, Win, WIN!

The notion that getting to reduce tax expenses because of a much larger reduction in net worth due to capital losses is a win is absurd. Tax-loss harvesting may make the losses less of a loss, but it is still a loss.

gurusw
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Re: Advice needed to make short-term investments in Taxable accounts

Postby gurusw » Sun Jun 18, 2017 1:25 pm

retiredjg wrote:As for the bond fund, whether you use taxable or tax-exempt depends on your tax bracket.


My Fed tax bracket is 28%. Also I am in CA, and the state tax bracket is 9.3%.

livesoft
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Re: Advice needed to make short-term investments in Taxable accounts

Postby livesoft » Sun Jun 18, 2017 1:34 pm

People sometimes ask if they should put their Emergency Fund in a bond fund instead of cash. Respondents sometimes say, "Bonds are risky. They can lose money." And that is definitely true. In such a case, if one estimates that bond fund might lose 10% of its value, then one can increase the amount in the fund by 10% to account for that contingency.

In the same way with a Down Payment fund, one can just keep investing larger amounts in the fund to take care of contingencies.

For us, our down payment fund grew so large that we could have made a down payment of 100% of the house price that we ended up buying. That's right, we could have paid cash. Will that be the case for the OP? Probably not.
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retiredjg
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Re: Advice needed to make short-term investments in Taxable accounts

Postby retiredjg » Sun Jun 18, 2017 1:44 pm

gurusw wrote:
retiredjg wrote:As for the bond fund, whether you use taxable or tax-exempt depends on your tax bracket.

My Fed tax bracket is 28%. Also I am in CA, and the state tax bracket is 9.3%.

I'd suggest a national short term tax-exempt bond. Vanguard has 2 or 3. I don't know of anything like that at Fidelity, but they do have a long list of NTF funds and ETF.

There are some CA muni bonds, but none are short term to my knowledge. I would not put much of my house money into an intermediate term bond fund myself. Too much risk for house money unless your plans are pretty flexible.

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TD2626
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Re: Advice needed to make short-term investments in Taxable accounts

Postby TD2626 » Sun Jun 18, 2017 1:47 pm

You should strongly consider only investing this money in CDs (or money markets/high yeild savings accounts). 2-3 years is saving, not investing. For such a short period, investment returns don't matter as much. Tax-exempt money markets may be reasonable based on the tax bracket but the difference probably won't be enormous.

That being said - if this expense is something that is totally discretionary (i.e. it can be reduced by buying a cheaper house or by delaying a house purchase), you may be flexible enough to take some risk. But keeping things in perspective is important - short term bonds are probably risky enough.

Only if you "don't worry about the risk" and "don't worry about loosing money" as livesoft wrote are stock investments a good idea. However, look at scenarios like the Great Depression and Japan's equity price bubble. Stocks can loose 90%+ and stay down for 30+ years. If you truly don't worry about this kind of risk due to very unusual or extenuating circumstances you haven't mentioned, then a case may be able to be made for taking some risk, but that's fairly unconventional.

FDIC insured products are likely the best option in my opinion for most of such a short-term investment.

livesoft
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Re: Advice needed to make short-term investments in Taxable accounts

Postby livesoft » Sun Jun 18, 2017 1:54 pm

TD2626 wrote:However, look at scenarios like the Great Depression and Japan's equity price bubble. Stocks can loose 90%+ and stay down for 30+ years. If you truly don't worry about this kind of risk due to very unusual or extenuating circumstances you haven't mentioned, then a case may be able to be made for taking some risk, but that's fairly unconventional.

If a broad-based index fund loses 90% of its value, would one have the guts to buy a house at that time? Would one even still have a job?
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grabiner
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Re: Advice needed to make short-term investments in Taxable accounts

Postby grabiner » Sun Jun 18, 2017 2:15 pm

livesoft wrote:I just invest in tax-efficient stock index funds in my taxable accounts no matter what the goal is. I don't worry about the risk and certainly don't worry about losing money. For instance, Vanguard Total Stock Market Index fund:

1. If it goes up in value, great! I pay either long-term capital gains tax or short-term cap gains tax when I sell (maybe), or ...
2. If it goes down in value, great! I get to tax-loss harvest and save on my taxes.
3. If it goes nowhere, then it is like a money market fund.

It's win, Win, WIN!

What are the consequences if such an investment would lose $5,000? $10,000? $20,000? Probably not a big deal because you would just change your house down payment goal or add money from your emergency fund.


The last point is key; see Placing cash needs in a tax-advantaged account on the wiki. If you will still have enough money in your taxable account to meet your shorter-term needs if the stock market crashes, then your taxable account can be all stock.

But you have to have the money somewhere, consistent with your risk tolerance. If you are going to spend $100,000 in three years, and have a three-year bond worth $100,000, you have the same risk level as if you had neither one. Therefore, unless you are going to change your asset allocation to be much riskier after you spend the money, you should have the money in short-term bonds or CDs in some account, and not count it in your asset allocation.

I did this in 2013, when I bought a home. I had a stock holding in my taxable account which was more than enough to pay cash for a home (but which would have led to a huge tax bill if I did that). I intended to put 20% down on a home. So I left my taxable account in stock, and when I signed the contract and got my mortgage offer, I sold just enough stock to make the down payment. If the stock market had dropped while I was waiting to buy the home, I would have sold my stock, harvested the losses, and still been able to make the down payment.

And I would have also moved money from bonds to stock in my retirement account at the same time, except that I changed my asset allocation because owning a home was a major change in my financial situation.
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gurusw
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Re: Advice needed to make short-term investments in Taxable accounts

Postby gurusw » Sun Jun 18, 2017 2:50 pm

grabiner wrote:I did this in 2013, when I bought a home. I had a stock holding in my taxable account which was more than enough to pay cash for a home (but which would have led to a huge tax bill if I did that). I intended to put 20% down on a home. So I left my taxable account in stock, and when I signed the contract and got my mortgage offer, I sold just enough stock to make the down payment. If the stock market had dropped while I was waiting to buy the home, I would have sold my stock, harvested the losses, and still been able to make the down payment.

And I would have also moved money from bonds to stock in my retirement account at the same time, except that I changed my asset allocation because owning a home was a major change in my financial situation.


Thanks for sharing your experience. Since I will be in the same boat, do you mind telling how you changed your asset allocation after owning house?

IMO the cash for downpayment would get converted into RE equity, hence increasing the risk factor of investment. Would you count RE in the same vein as Stocks for chalking out asset allocation?

e.g. let's say I have 500K for retirement & Stock:Bond allocation is 80:20
100K is for house down payment, and I end up buying 500K house with 100K down.
Should I change my asset allocation for retirement because now I have 400K long-term loan?

Thanks.

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Re: Advice needed to make short-term investments in Taxable accounts

Postby abuss368 » Sun Jun 18, 2017 2:55 pm

Considering the short period of time, I would not recommend investing this money. It becomes more important to protect what you have accumulated for your goal compared to risking everything in an attempt to get more.
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Re: Advice needed to make short-term investments in Taxable accounts

Postby grabiner » Sun Jun 18, 2017 3:08 pm

gurusw wrote:
grabiner wrote:I did this in 2013, when I bought a home. I had a stock holding in my taxable account which was more than enough to pay cash for a home (but which would have led to a huge tax bill if I did that). I intended to put 20% down on a home. So I left my taxable account in stock, and when I signed the contract and got my mortgage offer, I sold just enough stock to make the down payment. If the stock market had dropped while I was waiting to buy the home, I would have sold my stock, harvested the losses, and still been able to make the down payment.

And I would have also moved money from bonds to stock in my retirement account at the same time, except that I changed my asset allocation because owning a home was a major change in my financial situation.


Thanks for sharing your experience. Since I will be in the same boat, do you mind telling how you changed your asset allocation after owning house?

IMO the cash for downpayment would get converted into RE equity, hence increasing the risk factor of investment. Would you count RE in the same vein as Stocks for chalking out asset allocation?


I count the mortgage as a negative bond; I make fixed payments for the next 15 years (now 11), while if I buy a bond portfolio, the issuers make fixed payments to me at certain future times.

I don't count the home at all in my allocation. It has value as real estate, but it is more like an annuity: it provides me a place to live. If my home loses half its value because of a housing slump, I still have enough housing to live in it. But because of this annuity-like feature, I have a more aggressive asset allocation.

I went from 90% stock to 100% net stock; after buying the home, I kept a bond allocation equal to my mortgage balance. I am decreasing my stock allocation by 2% per year as retirement approaches, so I am now at 94% net stock.

e.g. let's say I have 500K for retirement & Stock:Bond allocation is 80:20
100K is for house down payment, and I end up buying 500K house with 100K down.
Should I change my asset allocation for retirement because now I have 400K long-term loan?


You have the loan, but you also have the house. If you count the loan as a negative bond, your net allocation will be over 100% stock, but that isn't unreasonable because you have assets outside your investments.
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gurusw
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Re: Advice needed to make short-term investments in Taxable accounts

Postby gurusw » Sun Jun 18, 2017 4:15 pm

Hi,

So if my bond allocation (100K) is substantailly lower than mortgage (400K), then what does it mean? Should I not buying the house yet? or do I need to move more money in bond allocation?

Thanks.

itstoomuch
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Re: Advice needed to make short-term investments in Taxable accounts

Postby itstoomuch » Sun Jun 18, 2017 5:53 pm

+ Livesoft.
+ grabiner
Whatever the short term investments, you may want to have them grow enough to keep pace with housing inflation. If you want to be safe, keep the funds in CDs or cash then you are {may be, depending on location} losing value relative to the housing cost.
I appreciate your concern. We are in a similar situation. Our Discretionary has been in/out of cash-stocks to anticipate a home purchase close to our son, in Seattle. Since we have no human capital, the Discretionary really has to work to keep pace, +12%/yr :( :? :x
ymmv
Last edited by itstoomuch on Sun Jun 18, 2017 6:54 pm, edited 3 times in total.
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aristotelian
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Re: Advice needed to make short-term investments in Taxable accounts

Postby aristotelian » Sun Jun 18, 2017 6:33 pm

I would consider a combination of short and intermediate term bond funds. If they go down, it is likely because interest rates are increasing in response to stock market gains. So in that scenario, you would sell stock to pay for your down payment. The odds of bond market and stock market both having negative return for 2+ years is very small, and if that type of event happened you might be rethinking whether to buy a house at that time anyway.

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Re: Advice needed to make short-term investments in Taxable accounts

Postby aristotelian » Sun Jun 18, 2017 6:46 pm

gurusw wrote:Hi,

So if my bond allocation (100K) is substantailly lower than mortgage (400K), then what does it mean? Should I not buying the house yet? or do I need to move more money in bond allocation?

Thanks.


The negative bond concept is interesting. However, one difference is that the mortgage is offset by the value of your home, which you could theoretically sell at any time.

Moreover, a big bond allocation doesn't make sense to me. Either you reduce your negative bond and pay off the mortgage, or you invest in stock hoping that over 30 years you will get better return than your negative bond rate. Especially in a low interest rate environment, you are likely setting yourself up to tread water at best with a large allocation in bonds to offset your mortgage rate.

I was 90/10 in my 30's without thinking about it, but we recently used stock gains to pay off our mortgage, so I am glad we did not go with a big bond allocation.


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