Help a Reader: What to Do with a Ton of Cash

Here's an email I recently received:

Several years ago, my wife and I decided to save for a down payment on a house, but to wait to buy until the housing bubble burst and we were able to get work in our city of choice.  To make a long story short, we've saved up far more than we need (enough for a down payment and 3-4 years of living expenses), so I'm looking for advice on investing the remainder.  The majority of our money is currently in a money market account through our credit union.  I was thinking about doing the following:

• keep 3 months of emergency fund in the money market account

• start a CD ladder of 12 month CDs on 3 month intervals, each of which is about 3 months' expenses, either through our CU or Vanguard.

• put the majority of the rest into Vanguard core funds.  I like the Wellesley Income fund for about a third of it and either the Wellington or Total Stock Market Index for two thirds.  The fact that the market is currently in the tank makes me think this is a good time to start, but how quickly should I ramp up the funds?  Perhaps 1/6 of my target amount per month?  Is that too slow or too fast?

• put a small amount into a Lending Club account

• possibly fund IRAs (Roth?  Should I get these through my credit union or elsewhere?)

In case anyone is wondering, we're both in our 20s, save about half of our net income, and contribute up to the matching limit in her 401k (should we increase this to the total contribution limit?)  I plan to eventually raise kids while she continues with her career.

Thanks for any help you or your readers can provide.

So, what advice do you have for him?

Comments

[Dave]

This is just my opinion:

Preface: It sounds like the most important thing for you right now is to get a financial adviser whom you trust. She or he can give you far more information about your investment choices.

1. I have never heard of a "Lending Club." Is this where people get together and decide what stocks to invest in? Whatever it is, it sounds extremely speculative. I'd avoid it all together.

2. You definitely want to fund and max out on your IRA's. Whether your qualify for Roth depends on your income. I would recommend getting them through a company like Fidelity so that you have a number of different options for where to invest.

3. I would bump up the emergency fund to 6 months or possibly even 9 months.

4. Personally, I think you are a bit young to have a CD ladder, but then again, I wouldn't want to put that much into stocks right now either (see below).

5. Finally, my personally opinion is that we have not seen the bottom in the market yet. That said, it looks like we're heading towards a fairly significant bear market rally over the next several months. The point is, there's no need to go all in in Vanguard index funds right now. Just buy an amount roughly equal to whatever lets you sleep at night. I don't know where you came up with 1/6 of your target per month but if that's what you are comfortable with, then that's what you should put in. Just be prepared for your investments to lose half their value or more over the next 2-5 years. Remember this is LONG TERM investing (i.e., 15+ years minimum).

[Brad]

Here is my opinion:

I don't think there is anything wrong with any of these ideas. However, especially considering the current economic conditions, why not put more down on your house? In buying your house, you are adding debt onto your personal balance sheet. This brings your total net worth down and commits you to years of interest payments that could end up being larger than the amount of your original loan. I would challenge you to eliminate the amount of debt you have outstanding before you commit to investing large sums of money, especially in vehicles that are difficult to tap in an emergency (ie. long maturity CD's, IRA's, etc.)

It sounds like you have plenty saved for any short, or long-term, emergencies. Think about paying off that debt so you don't end up being a servant to your lending institution.

[Emily]

I disagree with Brad... I would put less down on your home because the interest rates are so low. What do you have saved in your retirement accounts? That is a big issues... I would beef up that before you pay off your house. I would take an active interest in finance and figure out what you think is best. If your goal is to be debt free than pay off your house, but if you goal is to grow your wealth, I would consider investment options (and don't ask me for advice b/c I am horrible at investing)... Good luck!

[Bill]

Well done on getting into the position where your choices are all good ones.

Also - Choices are not either/or - you can do a bit of both.

1 - Your down payment should be at least enough to avoid PMI and all the associated nonsense. Your credit union is usually an excellent place for a mortgage. One reader said put some extra down on the house to avoid interest payments, and I would consider doing that, but it would not be my first recommendation. Given your savings habits you will opportunities to pre-pay your mortgage if you decide it is a good idea.

2 - If you are eligible for Roth IRAs, fund them. Do it through Vanguard with broad based index funds. This is a no-brainer. Do it before maxing out 401-ks, but definitely keep contributing up to the matching limit on the 401-K.

3 - Depending on how secure you feel with employment, and as it sounds like you don't have kids, 3 months emergency fund is OK. Young couples wqithout kids can make do a lot easier if something happens than those with kids.

4 - Rates on CDS are derisory at the moment. You will probably do as well and probably better with putting the money into blue-chip high dividend yielding securities - yield is higher, current prospects for appreciation are OK and they are more liquid than CDs if you need the money - you can sell them with a phone call without sacrificing 3 months interest. Johson and Johnson, Heinz, Kraft, Proctor and Gamble, Microsoft and Intel would all be attractive purchases.

[chynalemay]

STOP, sounds like you are confused as you "define" IRA's, So:...As a planner w/ over 16 years experience, GO GET PROFESSIONAL HELP! Contact a financial planner, either a fee based plan or by the hour, avoid a CPA planner as to avoid tax conflicts and sales oriented RR/Agents too.

Generally: income oriented assets should be in the tax deferred accounts (401K, 403b, IRA's, etc.,) and the capital gain treated assets (typically equities)outside the retirement plans to get maximum tax benefit. Emergency funds should be based on actual spending, job type and securtity. Forget paying off the house (after 20% equity to eliminate PMI) while working and the home is low interst AND deductible, instead: avoid consumer debt and save MORE! Max retirement plan(s) and IRA's via dollar cost averaging, be diversified (not just stocks but, bonds, REIT's etc.,) live well but, (20% or more) via funding your future. Don't forget some permanent life insurance either!

Retired at 47, I can "walk the talk"...

[Tim Manni]

This is the first blog post I've read in the past year that someone has saved waaay more cash then they set out to -- especially for a younger couple. While you're the envy of many, I say "salute!"

[QOAS]

I find the comments really interesting and helpful but I must say that after all the suggestions, its still your call, so you decide on it.

[Ari]

How about a purchase of a multifamily home that can bring in rental income and pay of the mortgage itself over time?

[LC]

First of all, I'm happy to see another couple where the wife is the major breadwinner and the dad is planning on staying home. You sound a lot like us, since we are also in our 20's and very stable financially. Here is what I recommend:

- Continue to fund the 401k up to the match. You only mentioned your wife's so if you are also eligible, you should do that too.
- Fully fund a Roth IRA for both of you every year ($10k total)if your income allows.
- Do #1 and 2 at a minimum, but if this is <15% of your total income, save the remainder of the recommended 15% for retirement either in a 401k or in a taxable mutual fund.
- Leave 3 months' expenses in the money market for an emergency fund.
- Save an additional 9 months expenses either in the money market or in a CD ladder like you suggested.

After this, it comes down to your own preference. If you are having kids in the near term, you may want to get started on a college fund in the stock market. If kids are further off I would suggest making a larger down payment on the house. We have been paying our mortgage down aggressively and have about 50% equity after 2 years. It gives us more peace of mind and saves a ton in interest, and we'll have it completely paid off before our children (due in a week) are in kindergarden. That will give us a ton of flexibility in work options, etc. I know some people are against this but as long as you still have enough of a cash cushion for emergencies, it really is a good idea in my opinion. You rarely meet anyone who regrets having too much equity in their house (other than retirees, maybe).

[Matt H]

The CD ladder is a good idea. It's definitely good to have some near-cash if you lose your job or something and you don't want to lose your house.

For the Vanguard part, if this is going to be a taxable account, stay away from income funds. They target dividend-paying stocks, and that's not tax-efficient. Indexes are much more tax efficient because they have very low turnover. But depending on what state you live in, Vanguard might offer some even better options for tax efficiency.

The place to go for a Roth IRA is Vanguard. Fund it to the legal limit. If you have a Roth 401(k) through your job, that gives you much higher limits.

Also, based on what I've read, you're better off dumping the stock portion of your allocation into the market all at once vs. dollar-cost averaging. Dollar cost averaging is good for invest-as-you-go, but when you have a pile of money sitting around, investing it all at once has better long-term odds because time in the market is more important that timing the market. All you can do is play the odds. You could end up kicking yourself either way, but there's no way to know in advance what the market will do. If you're really risk-averse though, go ahead and dollar-cost average it in.

If the idea is to earn the best return with the least risk, I'd say skip the Lending Club part. Conventional investments tend to have better rewards for each given risk level.

Before you get pro help (IF you do), take some time to educate yourself. There are good financial advisers out there, but if you don't know what to look for, you'll end up with an incompetent or a crook. Read the Wall Street Self-Defense Manual by Henry Blodget to start with. In particular, stay away from financial advisers who earn commissions by selling you investment products.

[Moneymonk]

fund Roth IRAs for both of you - TD ameritrade

[Kimberly]

If this were my money, I would set aside 6 months expenses in a money market for an emergency fund. I would then take $20,000 and set up Roth IRAs for me and my spouse for 2008 and 2009 (if income does not limit). I would probably go through T Rowe Price, because I have experience with them through my husband's 401k and they have low-cost index funds. I would take everything else and put it down on the house.

I would use the benefit of the smaller mortgage payment to dollar-cost average into the market. I'm still kind of afraid that the Dow will go down to 4000 or 5000, although I admit it's not likely.

[The Original Poster]

Hi everyone. The original poster here.

My wife and I did some more looking at IRAs, and are in the process of maxing out our 2008 and 2009 Roth IRAs (Vanguard index funds). We don't have access to a Roth 401k. My employer is a non-profit so I might have access to a 403b plan; I have to check my eligibility.

Those who've mentioned bumping up the emergency fund: the CD ladder is part of the emergency fund. A CD will mature once every 3 months, with just over 3 months worth of expenses in it. Think of it as a 15-month emergency fund with a better interest rate on some parts of it ;) My wife's job is extremely secure, and mine is fairly secure.

As for the down payment/house payment: interest rates on mortgages tend to be low enough, and the total amount we're looking at is small enough, that I'm comfortable putting down 20% and making regular payments; we'll certainly avoid PMI and such. At our current rate of savings, we're only about 6 months out from having enough saved up to be able to buy the house we're looking at (from an older relative) outright, but I think I'd rather put most of that money into other investments and pay off the mortgage traditionally. This is basically a matter of comparing rates and doing the math, and if it becomes more beneficial to pay off early we'll change strategies.

Matt H: your point about income funds is well taken. I'll discuss it with my wife and perhaps shift our investments accordingly.

Thanks for the advice, everyone!

[Luke]

I would:

1. Make sure all debt is paid in full, keeping at least 12 months of living expenses as an emergency fund. Keep the down payment money accessible and safe.

2. Contribute to the matching limits on both 401(k) and 403(b).

3. Contribute to Roth IRAs for both.

4. Increase living expenses to 18 months, with 6 months in laddered CDs at a lenghths between 12 and 18 months.

5. Take a trip. Have some fun. You're only young once!

6. Start a taxable account with Vanguard that you can DCA into an Index Fund - like the Large Cap Value Index.

7. Increase contributions to 401(k) or 403(b) depending on which has the better investment options. I imagine it would be the 401(k).

[Terry]

Vanguard bond fund (VFIIX) up this year,and last year. Current yield about 4.6% paid monthly. Check writing for $250 or more. Can buy or sell the entire fund ever 60 days (not recommended) under normal markets.
I'm looking for inflation coming back over the next 1-2 years,and you don't want to be in bonds.

[Limehurst]

I agree with DAve: get an adviser you can trust.

If you are a more self-directed person, I would suggest to go with the CD ladders first, then increasingly build your Lending Club account after you see it working for you.

I'm a Lender at Lending Club, and I have seen a good 5-6% of my portfolio default, but I'm still making 6-7%. The trick is to keep reinvesting the money and fine tune your lending criteria.

[aa]

1) 20% down in CD/MMA
2) 1-year emergency savings in CD/MMA
3) Maximize Roth IRA
4) Maximize 401k
5) Taxable

[Christine]

The some (Suze) is now saying you need like 9-12 months of expenses put aside. Why not put all the rest on the mortgage. A tiny mortgage leaves you more room to pay off your other debts or a pending little one. You could be debt free in no time at all if you keep savings and living frugally. It is such a good feeling to know that no one owns you and you are not a slave to any bank.

[frugal living]

I might be looking to try to own my own stripping and waxing company . I also do carpets to . Do you think i will make more money doing businesses or homes and apt ?

[GoldBuggg]

CD are "Certificates Of Death".

Individuals have been betrayed on a colossal scale and must defend themselves by exiting all assets and hunkering into cash. The betrayal lies at the feet of bankers, politicians, military brass, and corporate chiefs. By the way, cash is prescribed in that perfectly crafted document called the US Constitution. Gold & silver are the only forms of money that can legally satisfy debts public and private.

Those who believe that the US Dollar will prevail and survive this turmoil as the global reserve currency are precisely as incorrect as those who believed the US banking system could survive the mortgage debacle as it unfolded. We are witnessing a long slow drawn-out death experience for the US Dollar, liquidation of the US Economy, to be followed by a default by the US Treasury Bonds. During the panic phase, the response in the gold & silver prices will be profound, with advances to date only a prelude to a march to $2000 gold and $50 silver.

[kitty]

There are some good advice above, however, there is a vital piece of information missing here. What is a "ton of cash"? Is it 30K, 200K, 500K a million?

The advice should be different for each of these cases. For example, does one really need a financial adviser if one only has 30K? In this economy, most of it should probably be in money market/high yield savings/short term CDs just in case plus Roth IRA.

On the other hand, if one has 500K, one can diversify - max out retirement, keep some liquid savings in case of something like loss of job, and decide on other allocations - e.g. stocks, treasuries, municipal bonds, corporate bonds, commodities - with the actual allocation based on one's age, risk tolerance, etc. With such an amount, you need to educate oneself on various investment options or get a fee-based (not commissions) good financial adviser. Actually, having the adviser doesn't preclude educating yourself - it's your money.

@Bill "Rates on CDS are derisory at the moment. You will probably do as well and probably better with putting the money into blue-chip high dividend yielding securities..."

This is one option, but one needs to be aware of the risk and also keep in mind that stock dividend can be cut at any time as we've seen with GE, banks, FCX, PCU and shipping companies.

A less riskier (but not risk-free) alternative is individual bonds - assuming one has enough money to invest in a number of those. For example, I just bought an issue of Wells Fargo bond - maturity in 5 years, rate 4.95% (on $5000), but as I bought below par (i.e. paid less than $5000 - it was around $4400 if I remember correctly), the actual yield-to-maturity is 8.3%.

Yield-to-maturity takes into consideration both that the interest rate is counted from $5000 while I invested $4400 and the fact that I'll get $5000 at maturity. It's different from CDs in that the interest is not compounded but paid as income twice a year, but you can always invest it in something else. I also have Goldman Sachs bond as well as a couple of long term AA and AAA municipal bonds (tax free rate of 5% and 5.25%, yield-to-maturity - 5.3%). Individual bonds are different from bond funds in that unless the company defaults, you have a promise of getting back the face value of the bond at maturity. With bond funds, you always sell at current market value which may go up or down.
Bonds are more liquid than CDs in a sense that you can sell them. The problem is that when you sell before maturity you are selling at today's value on the secondary market.

Again, it depends on how much money there is. A minimum purchase for an individual bond is $5000 in face value (less if you buy below par, more if you buy above par). So if you want to have more than one so that you don't have all your money in one basket, you need a fair amount of money. You also should be OK with waiting till maturity. I currently have about 20K (in face value) in bonds, but I plan to gradually increase it at times based on the yields...

@GoldBuppp - "ndividuals have been betrayed on a colossal scale and must defend themselves by exiting all assets and hunkering into cash."
Wait, if the dollar is falling why would cash be safe? I miss something here...
Also, if the situation is as bad as you describe and the sky is falling, why do you think your gold is safe? Remember Roosevelt's gold confiscation? Nope, I don't believe this would happen, but if we are talking about total collapse of the economy here, surely you must entertain this possibility? Is your gold in Swiss banks? Also, if the world comes to an end, maybe a farm with one's own chickens and nasty dogs is a better idea? One can't buy bread with gold, can one?

One detail - low dollar actually benefits some US companies...

[The Original Poster]

Original Poster giving yet another response.

kitty: it's enough for a down payment on a house plus 3-4 years of living expenses, and it's enough that I'm talking about maxing out retirement while retaining some liquid savings and buying some stocks and such. I don't think I need to be any more specific. But thanks for the advice on individual bonds; I'll have to look into it in more detail.

Goldbugggggggg: when housing prices doubled over the course of about 5 years, real estate brokers kept saying "this is a great time to buy! These rises are just a prelude to the increased value you'll see in your home!" Yet house prices were clearly out of line with historical standards (as a ratio to income) and the speculation-and-bad-loan-driven housing market collapsed. Now, gold prices have tripled over the same timeframe. Why exactly should I trust gold brokers who say "this is a great time to buy! We're on our way to even greater values!"? The old adage is "buy low, sell high", and right now gold is high and stocks are low.

LC, Luke, aa, and others: sounds like I'm getting pretty similar advice from many directions. Here's what I'm going with:

- max out Roth IRA for 2008/2009 (Vanguard index funds), and fund 401k and 403b to their limits. Maximizes the amount of money that's tax-sheltered somehow.

- keep just over a year of emergency fund/expenses in MM+CDs.

- put almost all of the rest into Vanguard index funds (DCA over the next 6 months), and redirect ongoing savings into Vanguard index funds as well (should be about half of our take-home pay, after taxes and 401k/403b contributions.)

- because of how quickly we're saving and how slowly we're planning to move, I'm not holding the down payment in liquid form. I can rebuild it in ~6 months just by redirecting ongoing savings into a money market account.