Help a Reader: What to Do with $500,000

Here's a question/comment I recently received:

Perhaps it's because I've never had money in my life, I've had to work hard to save, but I find myself with cash (about half a million) in the bank but afraid to invest or buy a home or anything. I'm in my early thirties. I have zero debts and my wife and I earn a good wage but are forced to live in an expensive part of the country because of our jobs. Moving somewhere cheaper just isn't a real option right now. Does any one have any hard quantitative advice on how best to save for retirement in our case? We're wondering if we're better off not buying a home until we can move somewhere much cheap (perhaps 10 years from now). We have no stocks, no bonds, no 401k, nothing like that. Thoughts?

So, what would you tell this reader to do?

Comments

Send me a check and I'll take of it for you. No thanks needed.

[Jonathan C]

As an investor with a long time horizon (>20 years), I would put about 80% of the $500k into a total stock-market index fund, and 20% into municipal bond funds which are tax free. I would also be making maximum contributions to a Roth IRA for myself and my spouse each year for the next decade or two, to protect growth on as much of the principal as possible.

If you are indeed living in an expensive area, and the market hasn't been beaten down in the last year or two, I would probably consider waiting a couple more years for real estate to stabilize before pouring a large sum of money into a home. Where I live, housing has never been a phenomenal investment, but on the other hand valuations aren't tanking now either (like some places, i.e. Detroit, Miami, Phoenix or Cali).

Jonathan

I would do the following:

1. Pay off all outstanding debts. (you've done this one, move onto number 2)
2. Establish an emergency fund.
3. Invest at least 80% of what remains in index funds (adjust the stock and bond ratio based on your time horizon).
4. Use or save the rest at your discretion. If you are seriously considering buying a house I would hold onto the remainder as a down payment.

[Dar]

I'd find a nice home and put 20% towards a down payment, then take the rest and invest in a nice no-load index fund--stock is "on sale" right now and you've got 30+ years ahead of you for it to grow and grow! I'm sure others would want more diversity, but that's what I personally would do.

I wouldn't pay for the house outright. Use the mortgage interest as a tax deduction and take good care of the house so it appreciates.

Why do you have no 401K or other investments? It's nice that you have $500,000, but you could have quite a bit more if you hadn't paid taxes on it already (is this an inheritance or insurance payout otherwise?). You should definitely be looking at 401K and Roth plans and contribute regularly from now on to circumvent taxes.

You're well on your way to retiring comfortably and early with half a mill at your age--regular contributions to a 401K or Roth can only help you retire to achieve a more comfortable retirement, an earlier retirement, or some happy compromise between the two!

[LC]

If you plan to move in ~10 years I wouldn't buy a house in an expensive area. Continue to rent.

Sign up for your 401k plans at work to at least get the match, but contribute as much as you can afford. This will reduce your tax bill.

Set up a Roth IRA (at Vanguard?) and contribute the maximum ($5000 for each of you) each year. You have until April 15 to make a contribution for the previous year. This is after-tax money but you will never have to pay taxes on it again. This money can be out of your income, or you can move it over each year from wherever you keep the $500k. The only catch is if you make more than $169k (filing jointly), this is not an option.

Keep $20k in an emergency fund and don't touch it (like at HSBC or ING).

For the rest, I would set up some funds at a place like Vanguard. It's up to you how much risk you want to take, but I would put maybe 15% into an international index fund, 65% into a S&P 500 index fund, and 20% into an income fund.

The 401k and Roth IRA you can't get the money until you are 59.5 (with certain exceptions), but most of your money will be in a regular taxable account so you can use it whenever you want. Keep in mind that if you do move, you may be able to retire sooner than you think because of the extreme differences in the cost of living.

Go to Las Vegas and put it all down on one hand of Blackjack. You have nearly a 50% chance of doubling your money ;).

[Anonymous Coward]

Since it's such a large upfront sum of money I would see a fee based financial planner. It lacks that DIY "cool" vibe, but there are probably other considerations for half a million dollars all at once vs the slow incremental process we all do day to day.

One consideration is that putting it all into the market in a lump sum doesn't give you the advantages of dollar cost averaging. If you're investing for the long term, that's not so bad, but maybe not so good either (especially if watching your $500k go to $475k in a month would give you an ulcer despite knowing you're investing over the long haul).

Also, your financial planner might know of funds or opportunities available to someone willing to invest $100k vs $1k that would give you a much better return and take advantage of any tax breaks should you need them.

[Mr. ToughMoneyLove]

Hire a fee based planner.

Not my typical recommendation but this gentlemen is paralyzed with fear. This kind of fear is caused by a complete lack of knowledge and no confidence. Happens to all of us at some point. The cure is professional advice.

[Sarah]

With a time horizon of <10 yrs. in an expensive area I would definitely continue to rent if at all possible.

After the emergency fund and the IRA contributions, I would put the rest (*) into a targeted retirement fund (probably 2040-2045).

(*) I'm a little confused as to how poster came by this money. He refers to "working hard to save," but has no 401(k) or IRAs? If this money is savings from work, for heaven's sake, wise up and start contributing to tax-advantaged retirement accounts! If you are living in an expensive urban area, even if taxes do go up in the next half-century you are probably still earning in a higher bracket than you will in retirement in a lower-tax locale. If, on the other hand, this is an inheritance or other windfall, I would take maybe 5% of it out to spend on something you really have your heart set on, just so you don't feel too deprived.

[Tim]

The first thing you need to do is ensure your $500k is FDIC insured. You will want to set up multiple accounts (joint and individual) as well as spread it around to different banks because you are over the FDIC limit which is $200k for joint accounts and $100k for individual accounts.

[Ken]

You are nervous Nellie. ... Take $250K and buy zero coupon bonds that when they mature will be worth $500k... Now you are certain to have the $500k in the future. .. Now you are set up to invest the remaining $250k with the idea of maximum growth and the knowledge that would will be guaranteed to have $500k because of the zero coupon bonds. Take $125k and buy IYY, the total stock market index ETF. Take the remaining $125k and divide it between a small cap growth and small cap value funds. Small Cap mutual funds beat all others over the long term. This is the perfect portfolio for all nervous Nellies.

[P]

How can you not have a 401k, any stocks, etc.? It is 2008 right?

All kidding aside, you need to find a financial advisor because you need some real help to create a financial plan. The problem with getting advice from these comments is that there are so many variables that are unknown. Are you eligible for Roth IRA's, do you have a matching 401k plan, etc. That is why you need to go to a professional, pronto.

[Hectorartm]

That's a lot of money. Spread it around. Make sure you get under the FDIC maximums by putting that money into different savings accounts. Make sure they give you at least a 3% return. Then decide what to do very patiently. BE PATIENT PLEASE.

[dogatemyfinances]

Anyone who feels they are "forced" to live somewhere will want to just blame someone else. So, a financial planner, I say.

[shadox]

What an interesting situation. Many of the commenters have given excellent advice. Personally, I am interested in how you accumulate that much wealth in your early 30s without investing at all. Is there prodigious savings going on here? Is it an inheritence? Employee stock options? What's the deal. Just curiousity...

I agree with the comments on getting a fee based planner. You need to get comfortable as to what you find an acceptable level of risk. With $500K, your money will grow into a very large pile and you will live a very comfortable life in retirement.

[Sarah]

Two professionals whose parents paid for their professional schooling (i.e., who aren't encumbered with law or medical school debt) could easily accumulate that much money by their early thirties. (I am ruling out the financial industry--after these past few good years, if you've only accumulated $500K, you're well behind the curve there--because the guy hasn't invested anything in anything.) Or vesting options or selling the equity in a reasonably successful startup, but that's less location-dependent and he says he feels constrained. No, I vote for "Biglaw newly-minted partner whose mom and dad paid for law school."

[Kevin]

This guy needs a professional, he is obviously paralyzed with fear about losing or doing something wrong this money. I'd suggest he tap his network of contacts to see if anyone could recommend a reputable fee-based planner.

In the meantime, make sure the money is in separate accounts to get the FDIC protection. Especially with banks failing in certain parts of the country.

[Chaturon "Chubracabra" Wattaporn]

Briefly, here's my personal, nontraditional plan for financial freedom:
1. Put the money into several high-interest-bearing $100K bank accounts. Every $10K saved will generate approximately $1 per day in interest income for the rest of your life. (Note: There are arguably better alternatives to getting a 4 or 5% interest rate, but I won't detail them here. The point being: put your money in a safe investment where it will generate consistent passive income.)
2. Reduce your expenses as low as possible, including being debt-free (no mortgage). Invest in a relatively cheap home in a terrific location. Some great steals currently.
3. Attempt to live off the passive interest income and/or set up your own business that will generate either extreme capital and/or decent passive income. (For example, I am currently a freelance photographer pulling in $225K/yr with expenses of only $2.2K/mo. Am exploring microstock photography for passive residual income. Also looking at rental income from vacation properties. Personally, I don't recommend the stock market as it's basically gambling and I'd rather have more control and get better returns and tax deductions investing in one's own business, rental properties, etc.)
4. Travel, do whatever you want, live free!

[Doug]

Go to diehards.org for Bogleheads forums (Vanguard) for very, very good forums with many experienced investors who will help lead you in the right direction.

[james]

I think the reader has every reason to be concerned about where to put that cash. These are unique times in that every asset class -- commodities, stocks, real estate, bonds -- is experiencing simultaneous collapse. Welcome to the land of deflation, where that 500K you've worked your ass off to save can very easily turn into 300K -- your own personal deflation -- if you're not careful.

Forgive me for being so negative, but this bear is still in its infancy.

Let's break down potential investment vehicles.

Stocks? Sure, they are cheaper than a year ago -- and getting cheaper. This bear in stocks has legs, perhaps two more years and another 300 points down on the S&P. Not in a straight line, mind you, but the direction is definitely lower. I would recommend that if you think you need to own stock, buy in real small amounts using wide scales. But more importantly, I would look to emerging markets like India, China, Brazil in which to deploy at least half of your stock allocation. Their long term growth rates are very real, and some markets like China are already down 60%.

Real Estate? I don't think we've quite hit the nadir of despair when it comes to real estate, hence no bottom. We should not confuse a moderation in the rate of decline of real estate with the all clear signal. They time to buy real estate is when nobody cares about it, and the mere mention of it gets you funny stares. Not quite there yet.

Commodities? Will anybody be surprised if oil goes back to 60 bucks a barrel, which is still 4 times higher than where it was a few short years ago? A world economy on the brink of recession has less demand for fuel and oil based products, hence the price retreat (and this goes for most commodities in general). Ultimately the long-term trend in commodities is higher, but I suspect it will come from lower levels than where we're at today.

Bonds? The most toxic asset of them all, excluding government paper of course. Trillions of dollars of bonds are just sloshing around the financial system without anybody able to tell you what they're worth. And if one likes to think of the credit markets as more rational than the stock market, the credit markets are screaming more pain ahead for debt of a non-governmental sort, and ultimately pain for everything else in our debt-laden society.

My advice to you is definitely spread that money around different banks so that you're FDIC insured. Or it you prefer a single account, keep your cash in a money market account that invests ONLY in treasuries. You're yield will be pathetically small -- around 1 percent -- but understand that higher yields (above treasuries) requires taking more risk. Money markets can break the buck. A dollar today might be worth only 96 cents tomorrow.

The best way to grow that cash is to just keep saving on top of what you already have, and be patient for better buying opportunities -- especially in emerging markets -- over the next 12-24 months. Educate yourself as much as you can. With that kind of coin sloshing around in your account, you can't afford not to.

Good luck and keep saving.

[cherryblossom]

What about buying a foreclosed home. Can't say I know much about this but I do know you need cash to buy one.

[Sarah]

Chaturon: that would be great advice, if there were no such thing as inflation. Long-term returns that don't even consistently outpace inflation (such as you get on even a high-interest savings account) mean that the money will just erode away, even if you don't spend any of it. And you will. The "safety" there is nothing but an illusion. It's not just that other investments are "arguably" better--you *have* to do better than savings can do for you if you are thinking in the long term.

[Kacper]

Currently I will put most of it on some long term deposits (450 000$) and probably 50 000$ on saving accounts. Those 50 000$ I will use from time to time in some short/mid term investing on stock market.

[Richard]

However this person got this money, he should consider himself extremely blessed. The following two statements really struck me odd: "I've had to work hard to save" and "We have no stocks, no bonds, no 401k, nothing like that." Either way, it sounds like this person has a great opportunity to secure himself for the rest of his life, provided he thinks long term.

I'd agree he should talk to a fee based planner, but make sure that he understands the investments that the planner is recommending. Wikipedia, HowStuffWorks, and all the finance blogs can give information about every investing topic out there.

[MBirchmeier]

The first most important recommendation is what Tim recommended above: Make sure you're covered in the 100,000 limit for FDIC insurance. Move money around between accounts or banks, create new accounts if necessary to ensure this money is protected.

Secondly there are quite a few comments above recommending a financial planner. In my opinion this is the best for you.

I've you've managed to amass half a million a savings account rather than investment vehicles, It sounds like you might be risk adverse. While investing in long terms mutual funds etc. might be the 'best' solution financially it might not be the best solution for you. If you invest too aggressively and your investments drop 10% in the next month it will likely turn you off to investing. Talking to a financial planner to ease you into the process.

[Judy Hillerman]

Wow you and your wife seem very focused. Here is one way to look at this. There are many ways to invest/save your money for retirement, but if you don't have a home that is paid off, where do you think you can aford to live on that retirement. My suggestion is to invest in a property and meet with a finiacal advisor for the retirement savings. You are already on the right track you just need professonal advise.

[Nicole]

I have to join in with the other commenters who express amazement that you do not have a 401k or IRA. Both you and your wife need to enroll immediately in your employers' retirement plans. I am guessing that you haven't done so because you can't decide what investments to select. Most retirement plans have financial advisors who administer the plans - find out who they are and get their recommendations. You both also need to open up IRA's and max them out.

Put a portion of your savings in a separate untouchable savings account - that will be your emergency fund. It should be enough money to cover 6 months of expenses if you lose your jobs.

If you want to buy a home, then you should keep the money you plan to use for a downpayment in FDIC insured accounts while you are house-hunting (as others have recommended, you should spread the money among different banks so you don't go over the limit). You should put at least 20% down, but you can put more down if you want - there is no hard and fast rule about that. If you plan to wait more than a year to buy, you might want to consider parking the money for your downpayment in a CD - WAMU has the highest one out right now at 4.5% for one year. It is better than you will get from a "high-interest" savings account.

Whatever money you don't intend to use as a downpayment, invest in a mix of mutual funds (divided among large cap, small cap, medium cap and international) - again, get some advice from a professional on which funds are best, and do your own independent research. Don't get sucked into fancy schemes. If anyone tries to sell you anything except mutual funds, ETFs, or bonds, run for the hills.

[kitty]

I would wait with throwing any money into the market now except for a little at a time via dollar cost averaging, so I think I am with James. Sure, putting it all in CDs - spreading around into multiple banks to keep under FDIC limits, and maybe some treasuries wouldn't beat the inflation long term, but nobody suggests to keep this money in CDs forever. We may be looking for a period of negative returns, so why invest money now to have less of them two years from now? It is one thing when one dollar cost averages into the markets, but throwing large lump sum into the falling market doesn't seem like a smart idea.

Nobody says you should keep the money in CDs forever, but right now may just not be the good times to go into the market. Also, with any large lump sum it makes sense to give yourself time to think rather than to do anything rash.

Then, I'd wait and watch. Figure out market allocation - percentage to put into market, amount that might be needed for down payment for the next home, amount you are willing to risk on the market. In a year or two the situation with real estate and the markets may become clearer. You may even start investing into index funds - a little at a time, not all at once. But for the moment, IMHO, the best thing to do is to keep the money safe, wait, and educate yourself a bit about finances, investments.

[Mr. Budget Wise]

Well first let me preface this by saying I always tell my friends "YOU KNOW WHAT'S BEST FOR YOU!" before I give any advice, with that said I think you should:

1. Put $2,000 (individually) as a starting point to open up a Roth IRA for each of you.
2. I think that you should invest approximately 2% (10.000) of that income or even 1% ($5,000) into other investing mechanisms. My recommendation would be mutual funds or ETF's because the money is more spread out and diversified in these types of accounts, so there's very little risk and at 5% per year or more you could grow another little nest egg in that 10 years. Now is the time to buy cause the markets down and it's cheap, but the big thing is DO YOUR RESEARCH 1st!
3. You know you're not going to move until another 10 years. (You know what's best for you.) Don't worry about buying a house now! Keep saving until then. With that much money saved I would recommend buying your home outright so that no matter what happens you have a roof over your head.
4. You could send me a tax-free gift of $5,000 for my sound advice! As I am an artist in need of funds to promote my work. Okay I had to throw that in there. :)-

[the guy]

Thanks for all the comments! I'm "the guy". Most common question was how we ended up with our savings but no 401k and so on. Combination of things but basically we worked a few tough years in the US and abroad for companies without benefits but great stock options. We did spend enough along the way to live very well so it was fun as well as lucrative.

One commenter took exception when I said we are "forced" to live in a certain area. What I mean is that if we want to keep our higher profiting jobs (after costs etc) then we need to stay near certain hubs which have the vast majority of the higher paying jobs in our specialty. We plan to downsize when our savings are large enough and live somewhere lower cost and have a far lower income.

Another commenter mentioned "dollar cost averaging". The math doesn't support it being a good idea when one looks at the market data over long time scales. There is published research that backs up this opinion so its not just my whacky take on things. Although I don't work in the finance industry, I have a hard math job so I look at various goings on in the markets.. and the available products and frequently it just doesn't make sense to invest.

I'm digesting the rest of the comments and have continued looking at more options. Funnily enough several financial companies have recently offered me quantitative developer positions and roles related to building realtime algorithmic trading systems. Perhaps taking one of those may make my decision easier ;-)

[Tim]

To the guy:
Well, it seems your unwillingness to invest has paid off! The stock market is down for the decade. Keep in mind there are many other places to "invest" than the stock market. I'm still trying to figure this out myself since I am sitting on nearly $100k in cash (outside of retirement accounts). Perhaps a franchise opportunity??? For now, my money is sitting in CDs and Money market collecting between 3.5%-5%. Not great, but better than other investments this decade!

[Michelle]

We are under contract with a rental we have had for a long time.
Our capitol gain is about $560.
We have almost no dept and our house is paid 75% off. We are 44.

We don't want to pay the capitol gains tax so thought that maybe a 1033 would be a good idea.
We want to only invest in the 1033, about $300 of the total gain.
Ideas- pay off the balance of our home, about 100k. Buy another home and rent it and put away the gross.
Other ideas/ Afraid of the market at this point. Thanks for your input.