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Stick with low risk

Chris Farrell Nov 21, 2011

Question: Our primary aim is to have a deposit for a house in 3 years. We have saved a reasonable sum of money but did not want it to linger in a current or savings account for 0.75%. We are deciding either investing at low risk or paying off mortgage. We have to sell our current house to buy a new house. My mortgage rate is 4.99%, so after tax rebate it is about 3.99%. Most investing opportunities are giving us about 2% at low risk and 3-5% at medium risk. After tax one would have to take another 1.25% off the return. We would like some advice. Thanks, Tom and Anne, Boston, MA

Answer:  I know that you’re earning practically nothing on your savings account. Nevertheless, my advice is to keep putting money into your low-yielding savings accounts.

For one thing, you have a particular goal in mind: Buying a new home in 3 years. It’s a relatively short period of time (measured by market risk and return). I feel that rules out doing anything riskier with the money for now.

You would do slightly better on a rate of return calculation by putting your extra savings into your mortgage. But you would be locking up more of your savings in your current home. I think there is an advantage toward maintaining financial flexibility by keeping the money readily available to you while you prepare for the sale of your current place and purchase another.

In a sense, your new home fund will also act as a healthier emergency saving fund over the next three years or so. (I am assuming that you can’t pay off the mortgage completely. Even if you could, with a 3-year time horizon and the current economic uncertainty, I would still hesitate putting so much of my financial eggs in one asset.)

You could always put the savings toward reducing principal later on, if you decide to stay in your current home.

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