Investing While Saving For A Home: Wise Or Risky?

Saving for a house and investing are both important steps to building wealth. However, it can be challenging to decide whether to focus on one or the other, especially when saving for a down payment on a house. While investing in the stock market or mutual funds can provide higher returns over the long term, it may not be suitable for short-term savings goals like a house down payment. Here's a guide to help you decide whether to invest or save for a house.

Should I invest my retirement savings?

Saving for a house can be challenging, especially when you're also trying to invest for retirement. While there is no one-size-fits-all answer, here are some things to consider when deciding whether to invest your retirement savings:

The case for homeownership

Homeownership is a common way for Americans to build wealth. Monthly mortgage payments offer built-in savings through equity gains, and prices tend to increase over time, making it a smart investment. Real estate appreciation rates vary by region, but major US regions have experienced double-digit growth in year-over-year home price increases. Homeownership also hedges against inflation by keeping housing costs static and predictable, especially with a fixed-rate mortgage. Additionally, there are tax benefits associated with homeownership, such as deducting mortgage interest, property taxes, and loan-related expenses.

The case for investing in retirement

When it comes to retirement savings, starting early and contributing regularly can take advantage of compound interest and dollar cost averaging. With compound interest, you earn interest on your contributions and investment gains. Dollar-cost averaging involves investing fixed amounts regularly to weather market highs and lows, as in a 401(k). Employer-sponsored retirement plans offer diverse investment options, from low to high risk. There is a lower cost of entry for mutual fund and stock market investing, and you can benefit from employer matching contributions. Investing also offers more control and flexibility, allowing you to trade or sell if a stock or fund isn't performing well.

Evaluating long-term performance

Historically, the stock market has outperformed real estate investing, with an average annual return of 10.3% from 1926 to 2020. However, the market is volatile, and gains depend on riding out the ups and downs. In contrast, a home purchase may offer a lower but more stable return, with an average annual return of 8.56% to 9.96% when factoring in the down payment, transaction costs, and ownership costs.

Weighing the risks

Investing in the stock market carries inherent risks, and today's risk is considered high due to market volatility. A home purchase also involves significant risk, especially when putting down a large sum of money. The last recession taught hard lessons about the potential decline in real estate and retirement investments.

Saving for both

It is possible to save for both a house and retirement simultaneously. While renting can be a good choice in certain markets, buying a home can build equity and is often a better long-term option. You can lower your 401(k) contribution to get the maximum match from your employer and set aside the rest for a down payment. This way, you continue investing while also saving for a home.

Down payment considerations

The conventional wisdom is to save 20% of the purchase price as a down payment to get lower mortgage rates and avoid private mortgage insurance (PMI). However, this is not always necessary, as first-time buyers typically put down 7%, and some loan programs require as little as 3% or none at all. When planning, consider closing costs and moving expenses, as well as potential repairs or improvements.

Where to save your down payment

While a basic savings account may not offer significant returns, a high-yield savings account or money market account can be a good option for short-term savings. Certificates of deposit (CDs) offer higher returns but require you to keep your money invested for a fixed term. If you're saving for the long term, investing in the stock market through a robo-advisor might be worth considering. Just remember to start selling off your investments a year or two before purchasing your home.

Using retirement savings for a down payment

Using retirement savings for a down payment is possible but comes with risks. Withdrawing from a 401(k) or retirement account incurs taxes and a 10% penalty if you're under 59 1/2. Borrowing from your 401(k) is an alternative, but you'll have to pay interest and repay it within a certain timeframe.

Down payment assistance

Down payment assistance programs and low-closing-cost loans can help reduce the amount you need to save. Federal and state programs offer assistance through grants, low-cost loans, and the purchase of foreclosed properties.

In conclusion, deciding whether to invest your retirement savings while saving for a house depends on your financial goals and comfort with risk. Both homeownership and investing offer potential for wealth accumulation, but careful consideration of the pros and cons is essential.

What are the pros and cons of investing vs saving?

Investing and saving both have their pros and cons, and deciding which route to take depends on your financial goals, risk tolerance, and time horizon. Here are some of the advantages and disadvantages of investing vs saving:

Investing

Pros:

• Potential for higher returns: Historically, the stock market has averaged annual returns of around 10%, which is higher than the average returns from real estate investments.
• Liquidity: Investments in stocks or mutual funds can be sold relatively quickly if needed, providing faster access to funds compared to long-term savings options.
• Diversification: Investing allows you to diversify your portfolio and reduce the risk of putting all your money into a single asset, like a house.
• Lower cost of entry: You can start investing in stocks or mutual funds with a smaller amount of money compared to the down payment required for a home.
• Employer matching: If you invest through an employer-sponsored retirement plan, you may be eligible for partial or dollar-for-dollar matching contributions, essentially giving you free money.

Cons:

• Risk and volatility: The stock market is subject to ups and downs, and there is a chance of losing money, especially in the short term.
• Fees and taxes: Investing often comes with various fees, such as brokerage fees, management fees, and taxes on capital gains, which can eat into your returns.
• Complexity: Investing can be complex and requires a certain level of knowledge and research to make informed decisions.

Saving

Pros:

• Safety and predictability: Savings accounts are generally considered low-risk and provide a safe place to store your money, especially for short-term financial goals.
• Accessibility: Savings accounts offer easy access to your funds, allowing you to withdraw money without penalties or waiting periods.
• Fixed returns: Savings accounts typically offer a fixed interest rate, so you know exactly how much your money will earn over time.
• No investment knowledge required: Saving does not require the same level of financial knowledge as investing, making it more accessible to those who are new to financial planning.

Cons:

• Lower returns: Savings accounts often provide lower returns compared to investments, and the interest earned may not keep up with inflation.
• Opportunity cost: By keeping your money in a savings account, you may miss out on the potentially higher returns that could be achieved through investing.
• Limited growth potential: Savings accounts may not provide the same level of long-term growth as investments, especially for longer time horizons.

In conclusion, both investing and saving have their advantages and disadvantages. Investing may be more suitable for those seeking higher returns, willing to take on more risk, and looking for diversification. On the other hand, saving may be preferred for those who prioritize safety, accessibility, and predictability, especially for short-term financial goals like saving for a house.

What are some ways to save for a down payment?

Saving for a down payment on a house can be challenging, but there are several strategies you can use to achieve your goal. Here are some ways to save for a down payment:

Assess Your Financial Situation

Start by evaluating your current financial situation. Determine your income, expenses, and debt to understand how much house you can afford and how much you need for the down payment and closing costs. Check your credit score and debt-to-income ratio, as these factors will impact your loan eligibility and terms.

Set Clear Savings Goals

Calculate your savings goal by considering the purchase price of the house, the down payment percentage, and the closing costs. The down payment can range from 0% to 20% of the purchase price, depending on the loan type and your financial situation. Set a realistic savings goal and create a timeline to help you stay focused and motivated.

Develop a Savings Plan

Consider setting up a separate high-yield savings account specifically for your down payment funds. Automate your savings by setting up regular transfers or direct deposits into this account. Look for ways to cut back on expenses and increase your income to accelerate your savings.

Explore Down Payment Assistance Programs

Research down payment assistance programs offered by government agencies, lenders, or non-profit organizations. These programs often provide financial support to first-time homebuyers or buyers in specific professions or locations. Take advantage of these programs to reduce the amount of money you need to save.

Reduce Expenses and Increase Income

Cut back on unnecessary expenses, such as subscriptions, entertainment, and dining out. Negotiate lower rates on recurring expenses and reduce your outstanding debt. Consider taking on side hustles or freelance work to boost your income. You can also explore renting out your spare room, car, or parking space to earn extra income.

Save Windfalls and Extra Income

Commit to saving any unexpected income, such as tax refunds, bonuses, or inheritances. Make a plan for how you will use this extra money towards your down payment goal and ensure it goes directly into your savings account.

Remember to regularly monitor and adjust your savings plan as needed. Saving for a down payment requires discipline and commitment, but with a solid plan and consistent effort, you can achieve your goal of homeownership.

What are the risks of investing my down payment?

Investing your down payment can be risky, especially if you are working with a short time frame. Here are some of the risks you should be aware of:

• Market volatility: The stock market is volatile and unpredictable, and there is a chance that your investments could lose value, especially in a declining market. If you need to access your money quickly, you may be forced to sell at a loss.
• Short-term investment losses: Historically, the stock market tends to outperform real estate investing over the long term. However, in the short term, there is a higher risk of losses. The average bear market lasts around 9 months, but some have lasted longer, such as the Great Recession from 2007 to 2009.
• Timeframe uncertainty: You may think you have a 3-5 year investment timeframe, but what happens if you find your dream home sooner than expected? Selling your investments early could result in a loss if the market is down.
• Stress and complexity: Managing an investment portfolio while also navigating the stressful home-buying process can be overwhelming for some people.
• Fees and penalties: Investing often comes with various fees and penalties, such as front-load fees, early withdrawal penalties, and taxes. These can eat into your profits or exacerbate losses.
• Opportunity cost: By investing your down payment, you may be missing out on more stable and secure savings options, such as high-yield savings accounts or money market accounts, which offer better returns than traditional savings accounts.
• Risk of missing out: If you invest your down payment and the market performs well, you may still feel disappointed if you feel you have missed out on greater potential gains. This can create a sense of unease and regret.

It is important to carefully consider the risks and weigh them against the potential benefits before deciding whether to invest your down payment. It may be more prudent to opt for more conservative savings options, especially if you have a short investment timeframe or are risk-averse.

How can I save for a down payment faster?

Saving for a down payment on a house can be challenging, but with a few strategies, you can achieve your goal faster. Here are some tips to help you save for a down payment quicker:

• Set a clear savings goal: Determine how much you need to save by considering factors such as the price of the home, the down payment, and closing costs. Use the 28/36 rule to calculate the maximum amount of debt you should carry relative to your income.
• Develop a detailed savings plan: Consider setting up a separate high-yield savings account dedicated to your down payment fund. Automate your savings by setting up direct deposits or automatic transfers to this account. Explore options like money market accounts and certificates of deposit (CDs) to earn higher interest on your savings.
• Cut back on expenses: Reduce or eliminate unnecessary expenses such as dining out, entertainment, travel, and subscriptions. Negotiate discounts on insurance, cable, cellphone, and internet services.
• Increase your income: Boost your income through side hustles, freelance work, or a higher-paying job. Consider selling unwanted items or starting a small business to generate extra income.
• Explore down payment assistance programs: Look into first-time homebuyer programs, government-backed loans (FHA, VA, USDA), and local or state initiatives that offer financial support. These programs may provide grants, low-interest loans, or assistance with closing costs.
• Save windfalls and extra income: Commit to saving any unexpected cash inflows, such as tax refunds, bonuses, or inheritances.
• Monitor and adjust your savings plan: Regularly review your progress and make adjustments as needed. Stay motivated by tracking your savings milestones and celebrating your achievements.
• Consider investment options: While short-term savings should generally be kept in low-risk, FDIC-insured accounts, you can explore investing a portion of your down payment funds in the stock market or mutual funds for potentially higher returns. However, investing in the stock market carries more risk and may not be suitable for short-term savings goals.
• Evaluate your investment priorities: Weigh the benefits and risks of both homeownership and investing for retirement. Consider contributing to both goals simultaneously by lowering your retirement contributions temporarily while saving for a down payment.

Frequently asked questions