What should we be thinking about as we allocate our savings?
December 7, 2008 8:26 PM   Subscribe

We are a newly-wed, youngish couple (both 30 years old, both professionals) trying to allocate funds to two different projects: purchasing a first home in a very expensive metropolitan area and saving for retirement. What should we be thinking about as we allocate our savings?

Things we are already thinking:

1. A first home in the DC/Southern MD/Northern VA area is likely out of our reach for four years at least, and we won't be retiring for at least thirty years, probably closer to forty. Conventional wisdom says that young people saving for retirement should invest in high risk/high return stock indexes, but that if you need the money in the next four years, you should keep it relatively safe in CDs and bonds. Obviously this conventional wisdom is in tension: a house is partly a retirement investment, isn't it?

Caveat: While we don't want to sit out a potential market rally over the next few years with our money in CDs, we also want to someday live in something larger than our current one bedroom apartment. The prospect of a depression destroying our down payment has my partner pulling out hair. I say: who wants a house during a depression, when joblessness might require relocation and force a sale of the real estate at depressed prices?

2. We'd like to maximize our 401(k) contributions, but after maxing out the matching funds from our employers, we're wondering if it would be better to put that money into the house fund. Another possibility is piling the money into the 401(k) and then taking a loan from the account to pay for (part) of the down payment. Here, we are especially thinking of this advice.

3. Though we'd really like concrete answers to this question, some of our issues are definitely just about how to match our discordant risk-tolerances, and of course about the current uncertainty. Because of this, we'd appreciate general advice/tips/reading suggestions for young professionals in our situation, in this economic climate.
posted by anonymous to Work & Money (5 answers total) 7 users marked this as a favorite
These are complex questions some of which only you can answer -- with the help of a flat-fee (not commission) financial planner. You need to determine your risk tolerance in any case, and I personally would say that more conservative in every way is the watchword right now. You'll need to prepare for a stagflation or deflationary economy. Renting is certainly a viable option and was often needlessly derided during the housing boom, and look what happened there.

The 401(k) or IRA loan is certainly a possibility when it comes to that, but you need real job stability for the first (so you don't have the loan come due when you change jobs, or pay severe penalties), as well as other drawbacks -- and although there are advantages and tax advantages in particular to IRAs, the main thing you want to do now is put money away for the future whatever it may be. I would personally look at the IRA and especially Roth IRA, which offer penalty-free withdrawals for first-time home purchases, but you need to run some numbers with your tax guy to see what you can afford.

Basically you get the best bang out of each $1 to contribute to your 401(k) up to the maximum of where your employer matches. After that, contribute to an IRA, probably in your case a Roth, as you intend to use it for a down payment.
posted by dhartung at 10:36 PM on December 7, 2008

Obviously this conventional wisdom is in tension: a house is partly a retirement investment, isn't it?

To be honest, I think that's dangerous thinking. A house is first and foremost a place to live. It is also an asset (assuming that you, not the bank, actually owns it), that can be borrowed against, sold, or otherwise leveraged for other purposes. But it's primary function is as a dwelling -- the ramp up in values in many areas in recent years made a lot of people start thinking about houses as primarily investment items, with their use as places to live deeply secondary. But a lot of those people are in the middle of losing their shirts right now -- it's not an approach that has worked for everyone at every moment.

That said, you are right -- short term savings (like for a downpayment) need to be in more liquid and more stable options, while long term savings can go into illiquid and risky options. You make those choices based on priorities, your tolerance for risk, and your assessment of whether or not you will be receiving family help on things like your downpayment.

Finally, if we are talking early in one's career, make sure you are putting as much energy into maximizing your income as you are into your savings -- you can stretch a dollar pretty far, but compared to doubling your salary by switching fields, that's small potatoes. And the gains of that, started early, play out over the long term with very large impacts.
posted by Forktine at 6:00 AM on December 8, 2008

I'm in a similar situation (mid-late-20's, recently married, both employed by nearby counties at a teacher and attorney, considering retirement savings and whether it's time to buy a house). For now I've prioritized putting 10% of our salary into our retirement accounts (no matching, but still acceptable investments) with 90% stocks (index funds - mostly Vanguard) and 10% bonds (Vanguard bond index). Beyond that, we're putting away between $500-$1000/month to build up a down-payment. We'll probably have to increase that amount if we want to make a down payment within the next couple years ... the time when some suggest the housing market will turn around.

But this is mildly educated speculation (always a dangerous way to make decisions) regarding housing prices. The value of the house may quickly go up or down; our government jobs are relatively stable, but they could disappear also.

Scott Adam's (yeah, the Dilbert guy) recommendations:

Scott’s 9-Point Investment Plan

Do these steps in the order shown…
1. Make a will

2. Pay off your credit cards

3. Get term life insurance if you have a family to support

4. Fund your 401k to the maximum

5. Fund your IRA to the maximum

6. Buy a house if you want to live in a house and can afford it

7. Put six months worth of expenses in a money-market account

8. Take whatever money is left over and invest 70% in a stock index fund and 30% in a bond fund through any discount broker and never touch it until retirement

9. If any of this confuses you, or you have something special going on (retirement, college planning, tax issues), hire a fee-based financial planner, not one who charges a percentage of your portfolio

Investment priorities from bogleheads:

The general rule of thumb for investing priority is:
1. 401k/403b up to the company match
2. Max out Roth
3. Max out 401k/403b
4. Taxable Investing
posted by unclezeb at 6:32 AM on December 8, 2008

I'm not your financial advisor, but I'm in the same situation maybe just a few years ahead in terms of savings.

We live in a 1 bedroom too. With my spouse we figured we wanted about 60k-80k for a down payment. The first important step is to budget. Figure out how much you want/can save for a house down payment each year. Then automatically transfer it from your bank account right after pay day to a money market account or savings account. If you get a bonus, tax refund, or raise put all extra money in that account. Have a separate emergency fund of a few thousand. We have put all downpayment funds in money markets and CDs, since you/we will use the downpayment in less than 5 years.

I would ignore advice about when the housing market will go up or downdown. Do some internet searching and you'll find real estate people always think now is a good time to buy.

Now the 401k vs. housing. Get all the match you can. I think for someone our age you should aim for 10%, while you are building up your down payment, then move to 15%.

Finally, we are also going to wait to buy until we are sure which part of the DC area we want to live in. Due to our job its not quite clear, I wouldn't pull the trigger until I knew where I was going to be working for 5 years +
posted by akabobo at 8:04 AM on December 8, 2008

Just off the top of my head, looking at your query, my immediate question would be this: Do kids factor into this at any point for you? You don't mention it at all, but I don't want to assume kids aren't part of the larger financial picture unless you specifically rule it out.

Please MeFiMail a moderator if you can to let us know—I think knowing that would definitely help us better direct our answers. Because if kids are in the picture, another necessary component of the savings equation should be providing for their future, whether in the form of a 529 plan, a timed series of 10-year savings bonds, etc.
posted by limeonaire at 1:36 PM on December 8, 2008

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