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Saving for a Home

Chris Farrell Feb 20, 2008

Question: I am 27, married with my fourth kid on the way. I’m currently a full time student and working 30hrs a week at Starbucks, and my wife is a stay at home mom. Within this situation, we do not make a lot of money, but I do receive quite a few scholarships and grants that more than cover school and bills, and we don’t have any debt. We’d like to start saving some of this extra cash for our future home, which we plan on buying in about 5-7 years. I have looked at putting the money into CDs, but I want to know if there is a better way of maximizing a return on the money. Thanks for your time, Glen

Answer: I think you and your wife could teach all of us a lesson or two about the art of living well with little money–without taking on debt. In your situation and with your homeownership goal, there’s nothing wrong with parking cash in bank certificates of deposit. And as long as the value of the CD is under $100,000 there is no credit risk, either, since they’re FDIC insured. I’d would look at the after-tax yield you’re earning on the CDs to the aftertax yield you could earn on a comparable Treasury security. I would put my savings into whichever one is paying you a better aftertax yield.

But let me toss out a couple of other options for you to consider.

First, in this period of uncertainty, when the Fed is combating recession while crossing its fingers when it comes to inflation, putting money into a brand-name, conservatively run money market mutual fund can pay. The reason for putting money in “cash” is if inflation stirs and interest rates go up, the money market fund will start paying you those higher interest rates quickly.

Another option is a short-term bond index fund. Fees are low with bond index funds, and the portfolio itself is well diversified. You should earn a slightly higher yield in a fund like this, but at the cost of increased volatility.

My last idea is to consider adding a thin stock market layer to your savings, say, through a broad-based equity index fund. My thought is that quality stocks are getting progressively cheaper (they’ll probably head even lower in the months ahead). Your time horizon is long enough to justify taking on some extra risk to meet a specific goal. If everything works out, the finances of home buying will be that much easier. But if the market is down when you’re putting together a down payment–and it doesn’t make sense to sell stocks–the stock market portion of your portfolio won’t be big enough to prevent you from becoming a first time homebuyer.

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