Help a Reader: Where to Save Cash

Here's an email question I received recently:

I feel very knowledgeble about long term investments.  I feel I manage my retriement savings very well and this has been a top priority.   Over the past 5 years, I've cotributed all additional income to long term savings.  I have:

1) Maxed out ROTH IRAs for myself and my wife
2) Maxed out my 401k
3) Maxed out a HSA and I pay all expenses out of pocket so my HSA grows at the best rate

Now I just got a raise that will result in about $10,000 in after tax money available by the end of the year.   I wand to move in approximately the summer of 2012.   My current home is worth about $180k and I may likely move into a home valued around $400k.  I want to have my current home paid off by then.   Now, paid off could mean literally no balance or having the equivalent savings.

My mortgage is at 4.875% for 15 years.   So, its not very valuable to just pay toward that.   What investments would you suggest for the $10k for a time frame of 4.5 years?   

What would you suggest for him?

Comments

[AdamCO]

Traditionalists would say to put short-term savings into CDs. With possible deflation in our future, this makes a lot of sense. However, if you see inflation in our future, precious metals or even a stock index would make a lot of sense.

The deflation camp sees our money becoming more valuable as trillions of dollars are written off by banks because of bad mortgages.

The inflation camp sees our money becoming less valuable as the fed keeps lowering rates and working to stave off economic problems by increasing money supply.

I think your investment strategy should be based on whichever of these you subscribe to. I'm feeling inflation in the short-term but deflation over the next four or five years. If you're feeling deflationary, then that $10,000 earning 4% interest in a CD would be looking good, since the price of everything, from houses to washing machines, would decrease over the next few years. If you're feeling inflationary, that $10,000 at 4% would feel worthless as the dollar continues shrinking and general cost of living increases. Precious metals would protect it.

Okay, not sure if that helped at all, might just lead to analysis-paralysis.

By-the-way: where do you have an HSA that is actually earning a decent return? The best my company could find is a worthless return...something like 1%.

[Brion]

It depends on your risk tolerance.

If you want a risk-free rate you're unlikely to do any better than plowing those dollars into pre-paying your mortgage - that's a guaranteed 4.875% return on your money.

The only risk I see in that strategy is if the value of your current home were to fall and the value of the home/area where you want to buy stays steady or rises.

On the other hand, if you can tolerate some risk you can put that money into stock market. But given the current uneasiness in the market you'll need a strong stomach for this approach.

Good luck whatever you decide.

[klauss]

Call me crazy, but a dividend paying ETF is where I would put the flow. Although you have been slamming the market with Roth contibutions and 401k contibutions so it may be too much towards equities depending on the retirment allocation. I just do not see that many other good alternatives right now, with cash paying as little as it does currently.

[7million7years]

Have you REALLY managed your retirement strategy well? Better do some quick calcs to check:
1. What is your current Net Worth (try the CNNMoney calculator)?
2. What is your annual income goal to fund the retirement that you always hoped for? Multiply that by 20 to 40; depending on how certain you want to be that your money will last as long as you do ...
3. The difference between the two is what you have to make up (ADD a little more for inflation) between now and retirment.

If it's a little keep doing what you're doing; if a lot, maybe you need to think about INVESTING actively (business, real-estate, trading) rather just SAVING (CD's, 401K's, etc.).

[klauss]

7Million,

Your investing approach of "actively (business, real estate, trading)" sounds more like speculating and your savings approach (CDs, 401ks, etc.)" sounds more like investing to me. Just based on the statistics of individuals who trade rather than index...most get eaten up by fees while compounding growth usually is the better way to go using monte carlo analysis, But who knows what will happen in the future.

[CommRE]

To AdamCO - my HSA is at M&I Bank and pays 2.25%.

[beastlike]

Adam - Nice call, maybe do 50% in each since no one knows what will happen!!

My HSA has a min. that is required to keep in the saving/checking at 1.5%. Once you hit $3k or more, you can invest it into 7 different stock options as long as you keep 2k in the checking acct. Check if you have this.....

[Chris]

@ AdamCO - My company (large firm) has an HSA through Aetna insurance - not sure if it's available without the insurance end of it, but the HSA is managed and invested through JPMorganChase, I believe.

Last month ending 1/31, the APY on the account was 3.26%. Last year at this time, it was 4.11% APY, unfortunately I had just opened my account then and had very little money in it. Once you reach $2k, all of your cash can be invested in mutual funds, although they do suggest to use caution in using money that can leave you short of covering your deductible for the year.

[Brandon]

Something went wrong and my post wiped. Ugh.

Anyway, I think a CD or high-yield savings would be your best bet with that horizon. The rates should be similar to the rate you'd get with the mortgage and you'll still be able to deduct the mortgage interest. It seems like win-win to me.

[aa]

Conservative: Low tax bracket: 2-year CD; high tax bracket: tax-exempt bond

Moderate: Bond-fund/ETF

Agressive: Gold/bear market/reverse US currency ETF

[Zook]

Lets take a look at 2008:

You have $10,000 into the Roth's, $15,500 into the 401k and we will call it $5,000 into the HSA. That is a yearly savings of $30,500.

Man, you are ahead of the game. Congrats!

You need this $10,000 in 4.5 years...

How about a Target Retirement account set for 2015? Or 2010?

Vanguard Target 2015 (VTXVX) is 51% is the total stock market, 36% in the total bond market and about 13% over-seas and judging on how the Vanguard Target Income is positioned now, the Traget 2015 would be adjusting to roughly a 45% total bond market, 24% total stock market, 20% in TIPS, 5% in money market and about 5-6% in international for you allocation as 2015 nears.

This might be a tad aggressive for you, I don't know and this is just the net', but if you have nearly 5-years, you may want to place it in a professionally managed, single fund from Vanguard that will adjust to the date you will need the money. The expense ratio is like .19% as well.

For folks with time lines like this, where you need your money in exactly 5 years or 10 years, the target funds are a great fit IMHO.

I would love to hear folks who agree and disagree with this.. :o)

[Omniver]

I agree with Zook's suggestion.

[db]

A short-term goal (5 years to 2012 IS short-term) should be kept in something conservative.

I'd stay clear of putting it in stocks and stick it in a CD. The reason being -- it MAY grow more than a CD would over a 5-year time span, but it may also not.

With the current state of the economy I wouldn't be willing to bet on growth over a 5-year time span that I'm counting on not losing value.

At the very least, if you go with something riskier then look at something that pays dividends regularly, then BANK the dividends to hedge against loss of value. (For one example, go to Sharebuilder and look at some of the Eaton Vance closed funds like ETO or ETG -- with $10K you could buy 300 shares and get a MONTHLY dividend. That sort of thing. (I am not a financial advisor, don't just buy something because I mentioned it.) Don't go with an individual dividend stock for this goal, and don't waste time on an ETF/mutual fund that makes a skimpy yearly dividend payout.

However, I really don't recommend this idea for a short-term goal. I recommend sticking with a CD. Or maybe short-term T-bills if rates are outpacing a CD.

[7million7years]

Klauss, my point is this: IF your retirement plan is on track, then keep doing what you're doing.

But, the vast majority of people can't simply SAVE themselves into their ideal retirement; they have to INVEST in their future.

If starting a business, writing a blog, renovating an income-producing property, etc. is 'speculation' to you ... I simply say, bring it on baby!

[klauss]

I would agree with your last statement...

"If starting a business, writing a blog, renovating an income-producing property, etc. is 'speculation' to you ... I simply say, bring it on baby!"

Appears the individual can take a bit more risk with all of the contribution money, if absolutly necessary could be pulled out, in the roth.

The price on that 400k house is not likely to go anywhere on the upside over the next few years in my opinion anyway.

[Zook]

db-

Just curious. You jump from saying go with a CD and staying clear of stocks to suggesting 100% actively managed stock ETF's from Eaton Vance of all places if you want to get "risky" and then in the very next paragraph come full circle and say stay away from stocks and stick with a CD. Yeesh.

First things first. Are you suggesting opening up a 5-year CD right now? Divulge a bit more about your thoughts for CD's. I think for a 5-year time horizon, you would be silly to have it sit in a bank CD or play the CD laddering game with potentially woeful returns. This summer I would be surprised to see CD's in the upper 3% range, at best.

5-years may be "short" term for some, but I think 5-years is a long ways away and with that said, you better get a piece of the pie into stocks, especially a low cost, index if possible.

[Steve]

I agree with zook on this one. 5 Years is short in the overall financial perspective, but that is enough time to forge a decent return. Cd's at 3% aren't going to cut it. There are ETF's or "Recession Proof" stocks and relatively cheap value stocks that should give a decent return over a five year time horizon. It won't take much to beat 3%.

[JRich]

I decided to go with Zook's suggestion. By not wanting to contribute against the 4.875% mortgage, I all already stating that I am high risk tollerant.
For those interested, I have my HSA through USBank

The first $2500 earns about 1-2% interest, but beyond that, there are some funds including the fidelity lifecycle and a vanguard fund. So the return there is pretty good.