Planning on purchasing a home - best way to invest?

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supersharpie
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Planning on purchasing a home - best way to invest?

Post by supersharpie » Thu Dec 23, 2010 11:34 am

My wife and I bought our "starter home" in 2008 and it is perfect for our current needs. However, in 2021 it is likely we will have one child entering grade school and a toddler as well. Therefore we are going to need a larger home and preferably one in a better school district.

That being said we would like to have $120,000 saved for the downpayment and closing costs (10 years at $12,000/year). Our money market offers a 1.2% interest rate which won't even come close to keeping up with inflation, not to mention that the interest is taxed as regular income.

What are the best vehicles for protecting the buying power of our dollar that also offer a couple of percent of positive real rate of return?

I am thinking of some combination of:

VFIIX
VBLTX
VUSTX
VWESX
VBIIX
VFICX

All have offered relatively consistent 5 and 10 year annual returns of approximately 7%.

Are bond-based funds a wise investment choice for our purposes?

Do you have any other recommendations?
Last edited by supersharpie on Tue Jan 25, 2011 1:17 am, edited 2 times in total.

dbr
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Post by dbr » Thu Dec 23, 2010 11:43 am

Here are the current real yields (excess after inflation) of TIPS bonds at US Treasury. Note that shorter term TIPS are just barely positive in real yield but do offer compensation for inflation.

http://www.treasury.gov/resource-center ... =realyield

The trailing returns on the bond funds you listed are a result of falling interest rates over the time period and are highly unlikely to predict future returns.

Reaching for yield in long term bonds for a definite need within ten years is a really bad idea. Same applies to lesser degree in intermediate term bonds.

Individual TIPS might meet your requirement, as would a short term bond fund. TIPS funds are prone to be volatile and do not have the decreasing duration of an individual bond as you approach your goal. CD's are an alternative but have more inflation risk that may or may not be compensated by the current yield.

supersharpie
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Post by supersharpie » Thu Dec 23, 2010 11:57 am

dbr wrote:Here are the current real yields (excess after inflation) of TIPS bonds at US Treasury. Note that shorter term TIPS are just barely positive in real yield but do offer compensation for inflation.

The trailing returns on the bond funds you listed are a result of falling interest rates over the time period and are highly unlikely to predict future returns.

Reaching for yield in long term bonds for a definite need within ten years is a really bad idea. Same applies to lesser degree in intermediate term bonds.

Individual TIPS might meet your requirement, as would a short term bond fund. TIPS funds are prone to be volatile and do not have the decreasing duration of an individual bond as you approach your goal. CD's are an alternative but have more inflation risk that may or may not be compensated by the current yield.
Thanks for the advice!

I know that I am falling into the novice investor trap of basing a fund's value on past returns. However, considering it has only lost money 4 times in 28 years, would Wellesley Income be a fund to consider for our needs or should we steer clear of any funds comprised in part by equities?

dbr
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Post by dbr » Thu Dec 23, 2010 12:05 pm

Look at this chart on max range and decide if you would be happy if in the year just before you went house shopping your investment plunged by 20% or so.

http://finance.yahoo.com/q/bc?s=VWINX&t ... z=l&q=l&c=

Now part of the calculation is how sure you want to be that the money is there at a specific time. If you want to be sure, then you simply can't reach for return on the investment. That is a fundamental of investing you can't avoid. It is a decision about your objective being saving down payment and your objective being taking risk to hope for greater return.

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dm200
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Post by dm200 » Thu Dec 23, 2010 7:21 pm

Depending on the situation and the details of what you are doing, if you have a mortgage on the present home, you could pay the mortgage down more quickly, thereby having more equity in the present home, for use on the next home.

Your return will be your interest rate (less any tax savings, if any).

letsgobobby
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Post by letsgobobby » Thu Dec 23, 2010 7:33 pm

how do you know with such certainty that you will have children of exactly that age in 11 years?

A TIPS ladder or stable value fund or combination thereof held in a tax-advantaged account would be closest to meeting your need for preservation of capital and purchasing power with a fixed duration.

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Kevin M
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Post by Kevin M » Thu Dec 23, 2010 7:52 pm

You can get a safe 2.4% on an Ally Bank 5-year CD. With an early withdrawal penalty of only 2 months of interest, it's cheap to break the CD early if interest rates rise, and then invest in a higher yielding CD.

You can get 2.75% on a PenFed 5-year CD with a 6 month penalty, and 3.25% on a 7-year with a 1 year penalty. I understand that PenFed often has good CD deals in January, so you may get a better rate then.

With interest rates so low, I think these CDs currently offer better risk/reward than bond funds.

Kevin

Auream
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Post by Auream » Thu Dec 23, 2010 9:53 pm

dm200 wrote:Depending on the situation and the details of what you are doing, if you have a mortgage on the present home, you could pay the mortgage down more quickly, thereby having more equity in the present home, for use on the next home.

Your return will be your interest rate (less any tax savings, if any).
This. Even if you recently refinanced into a very cheap loan, say 4.25% (my current rate), you're still almost certainly going to come out ahead by paying down that mortgage than by investing in any type of low-risk investment (CDs, money markets, bond funds, etc.) If your loan is any higher than that, then all the better.

Wonk
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Post by Wonk » Fri Dec 24, 2010 10:28 am

Auream wrote:
dm200 wrote:Depending on the situation and the details of what you are doing, if you have a mortgage on the present home, you could pay the mortgage down more quickly, thereby having more equity in the present home, for use on the next home.

Your return will be your interest rate (less any tax savings, if any).
This. Even if you recently refinanced into a very cheap loan, say 4.25% (my current rate), you're still almost certainly going to come out ahead by paying down that mortgage than by investing in any type of low-risk investment (CDs, money markets, bond funds, etc.) If your loan is any higher than that, then all the better.
Agreed. Do this.

supersharpie
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Post by supersharpie » Mon Jan 24, 2011 8:11 pm

I wanted to revisit this thread and get your opinions on another option that I was contemplating.

Right now my wife and I are contributing 10k to Roth IRAs and 12k to 401k/TSP accounts. Therefore we still have plenty of tax-advantaged space to use.

We have decided that we are going to spend the next 3.5 years paying off the other source of major debt we possess besides our mortgage - that being my wife's student loans totaling about $66,000.

After we are finished we will have approximately seven years to save $125,000 to $150,000 depending on home prices. That will be a daunting task on two middle class salaries and one or two toddlers. I imagine that childcare alone for two children will be around $30,000 a year from ages 3 months to 6 years before they start kindergarten.

The new plan I have been kicking around is investing about 80% of our downpayment savings in our TSP and 401k accounts. This way we can allow our investments to grow without having to worry about tax ramifications during the accumulation phase.

Then each of us would take out a 5 year $50,000 (or whatever the max is in 2021) general purpose loan to pay the majority of the downpayment. The other 20% would go into taxable investments with guaranteed returns like a money market or CD. This money would be used for the remainder of the downpayment along with closing/moving costs.

Once we sold our home we would use the proceeds to repay the loans in full, likely only 6 to 12 months after the loans were issued. Should we not make $100,000 net of mortgage fulfillment and closing costs we would have 60 months to repay the balance to our retirement funds.

Obviously if we were in a financial situation where we had more than enough to max out both our Roth IRAs and 401ks AND save $125,000 in seven years in taxable investments then we would. However, realistically speaking there is no chance that we will be in this position.

Is there any downside to this plan? Is there any marked advantages to investing our downpayment savings in taxable accounts instead?

If we were to move forward with the aforementioned plan ought I not switch my wife's 401k from a Roth to a traditional?

Here is my rationale:

If we take a loan from a traditional 401k we will be borrowing money that has never been taxed and then paying it back with post tax dollars.

If we take a loan from a Roth 401k we will be borrowing money that has already been taxed and then paying it back with the same post tax dollars as we would a loan from a traditional 401k.

I suppose this might be a wash on the back end (assuming we spend retirement in the same tax bracket as we are right now - 25%) since the "double taxed" Roth money will be distributed tax free whereas the once taxed traditional 401k money will be taxed again upon distribution.

Thank you for any insight that you can provide!

supersharpie
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Post by supersharpie » Tue Jan 25, 2011 1:18 am

Fast board!

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