Hello hello,
Against my better judgement I recently got married and I am now planning on buying a house in ~3 years. I wanted to solicit advice from the wise, powerful, and good-looking WSO board as to how to best shift around my investments given I now have a rather large cash outlay expected in a few years.
My current investments are as follows: -$125k in US mutual/index funds; -$15k in US equities; -$75k in a global stock fund; -$20k in savings account/cash.
I'm assuming the house I buy will cost around $1.0M and wanted to place a $200k+ down payment.
Completely understanding that 90% equity exposure with a significant cash need in 3 years is not optimal, I wanted to see if there were options besides buying AAA bonds, 3 year treasuries, putting cash in a savings account that someone with experience in this matter would recommend.
Thank you very very very much
P.S. despite what my handle may indicate, I do not have any children (in case that would factor in to a response).
Buy the house now.
You can invest in residential REITs that are concentrated in properties near where you want to buy or the Case-Shiller futures for your city. Doing so may reduce your risk over just having cash or medium-term bonds if home prices go up.
Remember, REITs are leveraged.
Remember, there's a lot of basis risk.
But all else being equal, if the plan is to buy some sort of a house or condo no matter what, and higher home prices make your life harder, having some money in REITs may make some sense.
While at it, you may also want to buy puts on 10-year treasury futures-- they are a decent proxy for mortgage rates. This helps you lock in at a 4% rate in case mortgage rates later hit 5 or 6%.
I'd begin slowly converting some of your cash equities over to residential REITs. I'd also look at long-term puts on a treasury ETF in the very worst case.
Getting ready to buy myself in 12 months. A few thoughts:
distinguish between retirement and nonretirement savings. My retirement strategy is unchanged and my retirement accounts remain invested in "riskier" asset classes including emerging markets, growth stocks (both international and domestic), and so on. I have almost no fixed income investments in my retirement accounts.
Consider your liquidity needs based upon your savings today and expected interim savings. If you need to save more for a down payment, reduce your 401k and IRA contributions. In my case, I stopped making extra payments on my MBA student loan.
Given my shorter timeline I switched more of my nonretirement funds to balanced U.S. indices with a heavy fixed income weighting. I'm giving up some return, but cannot afford a 30-40% hit to my down payment.
Start liquidating any really illiquid holdings you have. For example, I owned some random preferred shares in several banks and also several bonds. Underwriters will assign these assets a large discount if they're not liquid.
Also consider tax implications. I purchased some of my holdings in 2009 and am sitting on huge capital gains as a result. I have been using tax loss harvesting to minimize the impact.
Small point. First-time homebuyers get to withdraw $10k from an IRA without penalty. IIRC OP has switched jobs in the past based on his post history, so some of his retirement money, if he has any, is sitting outside of a 401k. Note that you cannot do this with a 401k, IIRC.
In the end this is a drop in the bucket on a $200K down payment for a $1 million home. On that matter, I think a few other things are worth pointing out:
1.) A mortgaged home is a leveraged position. Your equity can go below zero. 2.) Income tax rates today are lower than they were 30 years ago. In 30 years, tax rates will probably be higher. This will work against the appreciation of a $1 million home. It may even lower the price. 3.) Interest rates are lower today than they were 10 and 30 years ago. Over both horizons they will probably be a bit higher. This will work against the appreciation of all homes, and may even lower their prices. 4.) Your interest rate will be half a percent lower if you can get a conforming mortgage-- that's a mortgage amount under $400-$600K depending on where you live.
5.) A bigger home is not a bigger asset- it is a bigger expense. It carries property taxes. It requires maintenance or HOA/COA fees. From garage door openers to air conditioners to ovens to lawnmowers, there's tens of thousands of dollars in machinery that you will need to replace every ~10-20 years. Heck, my tiny little condo has about $10,000 worth of appliances between the kitchen and HVAC units. That's before we get to the roof, windows, brick work, etc, which also have a ~30-60 year replacement cycle. Even the plumbing must be replaced every ~50-75 years depending on whether your pipes are copper or galvanized steel. (I am on the board of an older condo building). 6.) Every dollar you spend on a home, you will have to spend about 2-3 cents per year maintaining it. You will also have to spend 1-2 cents per year on property taxes. And you'll have to spend 3-4 cents per year on the amount you finance in mortgage interest (5-6 cents in terms of the payment). So that's something like $70,000 on a $1 million home with credit for a $200K down payment. If there's a way to reduce your price target to $800,000, it might cut that cost to $50,000/year.
So my point is, homeownership has some nice features to it, but don't treat it like an asset (other than something that lets you avoid paying rent and hedges you against gentrification), don't forget the hidden costs and don't buy more home than you'd rent. $1 million is a lot of money to spend on a house. Especially when the last $200K of financing is costing you $4,000/year extra.
My condo meets my needs. It's 800 square feet and in Chicago (if I were in NY, it would be 650 square feet and in Jersey City), but it also doesn't cost $1 million.
So you may want to consider aiming for the conforming mortgage limit-- so that would be a $800K home in an expensive part of the country (EG NYC or SF), or $615K in the rest of the country.
Wow, thanks very much. I hadn't even considered a majority of your points. That was incredibly helpful.
you are one of the most adept individuals I've ever come across when it comes to personal finance. You really should do a series of some sort, would be extremely helpful to all these college kids entering IB w/ ideas of "models and bottles". +1
Brilliant post.
Brilliant post, but you're forgetting that in most of America homeownership is considered a religious calling, not something to be thought of in rational, financial terms.
Bravo IlliniProgrammer
The above poster has some really good points about the carrying cost of a home. I originally only considered the mortgage payment, but in my state at least the property taxes are extremely high at 2.5-3% and the home value is reassessed annually (always upward). A 1mn+ house with a 200-250k down payment is a stretch if you're not making at least 200k and preferably >250k. Maybe that's just the conservative finance guy within me though.
some books
some books
I currently work in PE and I feel like valuations have been through the roof in the past year. We focus on a specific sector and typically invest at 6-9x ebitda and the past few months we have not been getting through the first bidding rounds with 10x bids.. aka some guys (none strategics) are biding 12-15x, which I think is crazy.
I am not a public markets guy, but I feel like high valuations in the private equity sector are often correlated with high valuations public equities. Now that being said, I am not a fan of dumping your positions because valuations are considered high, but considering you are going to be cashing out in a the near future I would consider selling a large portion of your equity portfolio and just holding on to cash. In other words I would be considerably surprised if the current market returns in equities continue for the next three years. I could, however, be completely wrong, but thats my 2cents.
People have talked about hedging against an increase in home prices or mortgage rates but I think a drop in the value of the equity portfolio is the most serious risk here to his ability to put a down payment on a house in three years. If the stock market were to drop that would likely lower house prices and rates (to the extent that they can be any lower).
Most scenarios where home prices and/or rates rise also have the equity portfolio maintaining its value.
I think a stock market crash is the biggest risk here (as it usually is) and should be protected against. I don't know where SP500 puts are trading at (or what a "good" price would be on these) but that's where I would look. FI markets are shit right now, it's hard to put a serious amount of money there IMO so I would look at the puts first.
Have $100k sitting in my checking account right now (bonus paid early), what would you guys put your money in...don't want single stock exposure and equities seem overpriced right now. Been slowly buying preferreds...thanks.
Question - do you have an emergency fund (3/6mos of living expenses in cash at all times that you do not touch)?
Couple thoughts:
1.) Gold looks cheap right now relative to inflation expectations and the geopolitical situation. I'd take a look at the GDXJ or GDX. Of course you can also do GLD. 2.) The Motley Fool thinks Berkshire Hathaway and Google are value stocks. Critically, Google is trading at 20 times forward earnings. 3.) The 10 year yield is up by 60 basis points since the election. Rates have gone from being unfairly low to just low. In a low rates environment, I like CDs. Number one, they often pay higher rates than treasuries. And number two, they often have a put feature; if rates get high enough, you do an early withdrawal and reinvest at a higher interest rate.
If you can get a 5-year CD with a 6-month early withdrawal penalty paying at least 2%, that's not a horrible deal. And when rates rise to 3% or 4%, you do an early withdrawal, pay your 1% penalty, and reinvest at a higher rate. Actually, there's one credit union offering a 7-year CD at 3% right now, but I'd check to make sure they have a fair early withdrawal policy:
https://www.depositaccounts.com/banks/andrews-federal-credit-union/offe…
But CD rates haven't quite caught up to the treasury market yet. So I'd wait a bit unless you're getting an awesome deal. (The 3% CD might be)
4.) I'm a perma-bull on MLPs (full disclosure), but they look cheap right now and a Trump presidency means the natural gas pipelines are going to be safe from any immediate carbon regulation. Some pipelines are paying a sustainable and moderately safe yield of 6 or 7%. Mind you, these entities generate UBTI (meaning you can't hold them in an IRA) and are also flow-through entities for tax purposes, like REITs, so you're going to pay more than LTCG on the distributions and you'll also have to fill out a K1 at tax time. But they might be worth it.
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