How to Save and Invest for a House Down Payment

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By Donna Fuscaldo

Rising home prices and stricter borrowing standards have put saving for a down payment back on the agenda for many homebuyers. The days of low or no down payment borrowing are gone, even as mortgage rates have remained low for the time being.

Saving to buy property can be tricky, however. Investors preparing to make a down payment typically face a short time horizon, and possibly a moving target, as real estate prices rise rapidly in many parts of the country.

This makes the traditional advice for short-term goals -- keep your savings liquid and protected -- a test in patience and restraint. It cannot be easy to watch home prices rise steadily each month while you are slowly stashing away funds in an account that earns next to nothing in a low-yield environment.

What should investors do? When it comes to saving for a short-term goal, there is no secret trick. Resist the temptation to seek higher returns, when those higher returns come at the cost of higher risk. "If you need money for the short term, you need to be more conservative," says Bob Stammers, director of investor education at CFA Institute. "You can't take swings in asset prices. You can't have the market take a downturn before you need the money."

The Bucket Approach

When you have goals with different time horizons, working towards those goals in separate investment accounts can help you stick to your plan.

It can be frustrating to funnel cash into a savings account month after month and watch it do nothing for you while your stock portfolio grows. You have several decades for your portfolio to grow, why not throw in the house down payment money in there and take your chances? You can always sell out when or if the stock market takes a downturn, right?

It is this line of thinking that can lead to bad investing behavior, says Aaron Gubin, head of research and wealth management at investment firm SigFig. Investors are more likely to panic during a market dip and sell out when assets earmarked for a short-term goal are bundled together with longer-term assets.

Keeping short- and long-term assets separate, on the other hand, will help you stay on course.
Gubin offers the following guidelines for investors looking for the optimal saving and investment vehicles for their shorter-term goals:
  • If you anticipate needing the money within six months to a year, keep it in an FDIC-insured checking or savings account.
  • With a time horizon of a year to three years, CDs or a short-term fixed income portfolio might make sense. This way, you protect your principal, but still get some growth to offset inflation.
  • If you have three to 10 years before you need the money, a blend primarily composed of investment grade fixed income and some equities provides risk management through asset class diversification, while still providing quality returns.
  • If your goal is 10 or more years in the future, consider a balanced portfolio of 60 percent equities, 40 percent bonds and adjust it, if necessary, for your risk tolerance (Or take SigFig's online risk questionnaire to determine an asset allocation based on your time horizon, risk appetite and other factors.) As your goal approaches, gradually dial down the equity portion, until you find yourself a year out. Then move the assets to the safety of an FDIC-insured bank account.
As always when making financial decisions, investors should make sure they understand the tax consequences. Everyone's situation is different, and a tax professional can help in figuring out what is most beneficial for you.

Donna Fuscaldo is a contributing writer at SigFig. Nearly a million people use SigFig to track, improve and manage over $300 billion in investments.
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