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What to do with savings

Question: My wife and I are trying to figure out where to put $7,000 just sitting in our savings account. My wife is in graduate school and has both a subsidized and non-subsidized federal loan. We have about 5 months of my take home salary in "savings" (Roth IRA, Mutual Funds, and savings account) - I'd like to have 9 months. Finally we would like to save for a down payment for a home. My question is where should I put the $5,000? Roth IRA? Mutual fund for the house down payment? Or should we just pay down my wife's unsubsidized loan? Thank you! Mark, Wellesley, MA

Answer: Well, you really can't go wrong with any of the options you've mentioned. However, it's unclear how the $7,000 fits into your 6 to 9 month savings fund. For many folks 6 months of salary in savings is good enough. But there's nothing wrong with having a bigger cushion. It just gives you a larger margin of safety if something goes wrong.

So, if the $7,000 is your 6-month cash cushion I would stick with safe savings that you can get to easily. I don't think there is anything wrong with simply letting the money "sit" in your savings account or, better yet, in a similar safe investment that might make you a bit more money, such as short-term Treasury bills. (And if interest rates go up the increase will show up right away in T-bills.) You'll only earn a fraction in interest, but you won't lose anything either. It's safe money.

If the $7,000 is in addition to your emergency savings one way to think this through is to ask: Will there be expenses associated with your wife making the transition from graduate school to career? Will you move for the job? Will she need a new wardrobe or a car? If the answer is yes to these questions, I would also stick with safe savings. The money will be there when you need it to pay for her transition to a new job and, in the meantime, shore up your pool of emergency savings. Over a longer period of time, if it turns out you don't need as much as you thought it can go toward a home or paying off student loans when you're a full-time two-income couple again.

Again, let's assume that you really don't need the money in the short-run and that the money isn't part of your 6 months savings cushion. In that case an attractive choice may be a Roth-IRA. When you withdraw the money in retirement the gain is tax free.

Here's the thing: If you suddenly realize a year or so from now that you guessed wrong and you do need some of the money you can withdraw contributions penalty-free and tax-free from the Roth. In other words, a Roth is a long-term savings plan but it offers you the option of treating it as part of your emergency savings fund, too.

The maximum contribution into a Roth for the 2009 tax year is $5,000. So you would still have $2,000 left over. I would put some of the the Roth money into safer investment choices so that you don't risk losing money on your investments if you have to suddenly withdraw money.

So, I vote for sticking with safe savings or going with the Roth.

Does anyone else have additional thoughts or ideas? I'd love to hear them. Thanks

About the author

Chris Farrell is the economics editor of Marketplace Money.
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