Saving to Buy a House
If your short-term goals include saving for a home, then consider the following saving and investment strategies:
Municipal Bond Funds
These investment vehicles offer income that is free from federal income tax and, in some cases, state income tax as well. You should consider short- or intermediate-term funds, depending on how long you plan to save for your down payment. This type of investment vehicle offers instant diversification and the guidance of a professional money manager. Be aware that intermediate-term bond funds have a slightly higher risk. However, if you can wait until the maturity date before you withdraw your money, these funds may offer a better return on your investment. Usually municipal bond investments have a lower yield than taxable investments. They generally make sense for people in higher tax brackets. If you are in a lower tax bracket, you generally will make more with the higher yield of a taxable investment than you lose in tax on what you earn.
Certificates of Deposit (CDs)
These are a smart investment choice if you have short-term savings goals, six months to one year. You should look for the highest-yielding CD possible. Of course, the longer you can keep your money in a CD, the higher the return on your investment. CDs are among the safest investments because the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration insure most CDs for up to $100,000. When placing investments in bank vehicles, watch the inflation rate. You should avoid investment vehicles that have a lower yield than the inflation rate. These can be a slow death for your savings.
These generally earn higher short-term interest rates than bank CDs. Money-market funds invest in the short-term commercial paper, which is a kind of debt, issued by banks, large corporations and the government. If you are a year or two away from purchasing a new home, this type of fund is a smart investment. If you have more time to save, however, switch to higher-yielding investments. Do not confuse money market funds with bank money-market accounts. The latter offers a comparatively small return on your investment.
Mutual funds for short-term gain
These funds generally earn an even higher yield. Mutual funds invest in stocks or bonds or a combination of both. Usually they are NOT insured. Although you have the potential to earn higher return, you also have significantly higher risk of loss with mutual funds. For purposes of saving for home purchases, you will want to invest in equity funds which are safer thangrowth funds.Stocks give you the greatest potential for return, as well as the greatest amount of risk. You should allocate a portion of your savings to long-term growth stocks and limit the amount you invest in the stock market until you save enough for a down payment for your home.
Individual Retirement Account(IRAs)
It’s never too early to plan for your retirement. You should regularly set aside some money in an IRA. Your earnings accumulate on a tax-deferred basis, so your money compounds faster.
If neither your employer nor your spouse’s employer offer a qualified plan, you may deduct your contributions to your IRA. In some cases, you may deduct your IRA contribution even if your employers do offer retirement plans. Married couples with adjusted gross income (AGI) below $50,000, and single persons with an AGI below $35,000 are eligible for a full or partial deduction of IRA contributions even if their employers offer retirement plans.
If you are dissatisfied with your IRA’s performance, transfer your balance to a different trustee. With trustee-to-trustee transfers, no money is distributed directly to you and the transfer is tax-free. There are no restrictions on how often you can make a transfer. Many banks offer special rates on CDs for IRAs. Before investing in an IRA CD, be sure to shop around.
A 401(k) plan is one of the best ways to save for your retirement. It enables you to contribute pre-tax dollars that compound interest on a tax-deferred basis. This means that you do not owe taxes until you withdraw your money at retirement. Unlike traditional pension plans, you must actively manage a 401(k). Monitoring and managing your plan is an important and necessary task since it directly affects the balance of your savings at retirement. Remember to regularly view your plan’s investments and diversify your 401(k) assets. The closer you get to retirement, the less risk you should take and the more you should consider fixed-income investments.
To get the most for your money, contribute to the plan as soon as possible. For example, if you place $7,000 into a 401(k) plan each year for 20 years and earn a return of 8 percent, your total assets will equal $320,000.
Employers generally offer several options for investing your 401(k) contributions, including fixed-income investments, such as CDs, and variable income investments, such as stock or bond funds. Many companies also offer matching contributions. Some employers match your contribution dollar for dollar. Others contribute 50 cents for every dollar you contribute. Still others contribute a percentage of your salary depending on the amount of your contribution. Be sure to ask about your company’s matching contribution policy. For the greatest yield, contribute as much as possible to your 401(k) plan. Typically, companies allow contributions of between 2 percent and 15 percent of your salary.
You may withdraw funds from your 401(k) plan when you reach the age of 59 ½ or in the event of death, disability, separation from service, retirement, or termination of the plan. With some plans, you may withdraw funds during financial hardship; however, you cannot draw on your employer’s contribution or income earned by the fund. In some cases, a 10 percent early withdrawal penalty may apply.
Mutual funds for long-term gain
You may want to consider stashing some retirement money in mutual funds. Mutual funds are overseen by a professional money manager who ensures that the fund is invested to meet specific goals identified in the fund’s prospectus. Some funds are designed to invest only in high-risk investments. Others specialize in low-risk investments. Still others offer a mix of low- and high-risk investments.
Diversification can give you an added measure of security yet enable you to benefit from upswings in your funds’ particular stocks. Be aware that there are many types of mutual funds. Income funds, orgrowth funds, are designed to generate a steady stream of income in the short-term. Yields are generally higher than CDs and money-market funds, but so is the risk. In many states, the interest from municipal bond funds is exempt from both federal and state income taxes. Shop carefully to make sure the funds you choose match your investment needs and goals.
With the proper road map, you can anticipate and successfully navigate your way around the curves, bumps, and detours on the road to financial independence. Have a safe trip!