Is a mutual fund the best way to save for a first home?

Question

I'm looking in 3-4 years to purchase my first home. I have been currently saving for it, but if there was a decent way to marginally increase the overall downpayment that would help in the long run. I could buy into a blended mutual fund which has decent returns.

Is this an okay way to do it without being hit with penalties or are CD's a better way to accumulate this money?

Answer 1

It really depends on which funds you're actually investing in, but I'd think most financial planners would advise against it.

You'd have to start first of all with the issue of cost. Are you buying a mutual fund that has an upfront sales load? Some can be as high as 5.75%. This means you lose 5.75% of your principal balance, the minute you buy it. Just to break even in 12 months, this fund would have to gain in value by 5.937% (since you're only actually investing $9425 of every $10,000 paid).

On top of that, even with a no-load mutual fund (the only kind you should consider), there's annual maintenance and 12-b fees. These can run from 0.80 - 2% or possibly higher. So you need to add that on top of your minimum gain just to break even after 12 months. It gets a little better on the money invested over time, because you only pay an upfront load once, but the annual maintenance costs remain.

You wouldn't be investing into a tax-advantaged account, since those are more difficult to withdraw from, no point if you know you will be in 3 years. You can actually have to cut a check for taxable gains from your mutual funds, even if the actual cash value of your investment has dropped. Yes, you read that right.

So. You basically have to earn 8% annually just to break even after the first 12 months. More like 10%, to cover taxes. Your safest bet is a no-load index fund, like a Vanguard/Fidelity S&P 500 mutual fund, or buying QQQ Nasdaq tracking stock. These could very well get you 10% annually. Over time, that's what it has done. But in 2-3 years, you could also lose 20% of your principal, without having enough time to let the market return and get your money back.

Much better to, as you suggested, buy some laddered CDs. Possibly even short-term Treasury bonds/T-bills? It's not hard to find FDIC-insured money market/savings/CD's out there that are paying 5-6% right now. Guaranteed return. Guaranteed to not lose principal. Guaranteed to be repaid by the government if the bank goes under somehow. 3-4 years time just isn't enough to want much exposure to loss of principal.

Maybe get a good savings account. Dump money in there for 3 months, then put that into a 3 month CD. Start over, then combine the balances into a new CD (better rates are common with bigger balances). Keep doing that, reupping the duration of your existing CD's to squeeze higher yields when possible. Watch it grow. Lather rinse repeat...

First step, identify a bank that is paying high yields. Bankrate has local searches you can do. Your local paper probably has a weekly listing of rates. Check the print ads too. Then go talk to a banker about what you want to do. Figure out roughly how much you'll put aside monthly, and you and your banker can figure out the best way to put that money to work, looking at what tiers you'll hit for getting higher yields, when to combine balances, when to buy a 3-month CD to have it mature when your others do. All that good stuff. If rates are rising, keep the money in shorter-term CDs. If rates are dropping, put it out as long as you can to protect your high yields...

Answer 2

You have to remember something, the only thing certain in life is taxes and death. Any way is good when you can make a profit. Normally the higher the profit capability, the higher the risk. There could be another 9/11 next week (GOD forbid) but it would wipe out most mutual funds. You could take your savings and go to Las Vegas and bet all of it on black. Your odds are almost 50/50. If you spread your money around you will also lower your risk. If there was a sure way, there would be a lot more millionaires, and don't listen to the infomercials either.

Answer 3

Pay attention to the mutual fund's expenses: the purchase fees, the selling fees, the yearly expense ratio. Only then should you compare like funds' performance. Index funds usually have the lowest expenses and fees.

One other thing to consider: Are you paying interest on any credit cards or loans that have an interest rate above 10% APR? If yes, then pay off the loans/cc's first. You'll save more in interest by paying them down than you could make putting the capital in an index mutual fund, which pays on average 10% per year.

Answer 4

If you have a 3-4 year time horizon MFs are an excellent way to invest. Look at the 3-5 year and 10 year annualized returns. Chances are the next 3-5 years will be close.

If the economy is going to h***, then pull out the money in the MF and go to CDs.
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Answer 5

You have a pretty short time frame. Mutual funds on average will be better, but in that time frame you might actually lose money. If you were willing to take the risk, then go for it. I would suggest CD's if 5%-10% drop is going to hurt you.

Answer 6

It depends on your market. How much is property appreciation in your area? You may be better off buying now with little to no down payment unless your investments will be making more than the local appreciation.

There are tons of first-time buyer programs that will allow you to purchase with little to no money down. Some will allow you to roll in closing costs or the Seller can pay them.

Good Luck!