Should you invest your down-payment money?
No one likes to see their money sit and earn nothing, especially when stock markets continue to move higher. If historically markets tend to perform well, shouldn’t one just take all of their money sitting in cash and get it invested? One of the most frequent questions I receive is about what to do with money set aside for the specific purpose of being a down payment on the purchase of an apartment. I probably get this question at least two to three times a week, and my response usually leaves the apartment hunters frustrated.
You can’t afford to lose
Most of those who ask me this question have shortterm time horizons, usually in the one- to two-year period. This means they are planning on buying a home within the next 24 months. As such, my advice is to NOT invest the money in anything with an element of risk. Why? The answer is simple. Because this money is earmarked for a down payment, and if the market were to get smacked down by 20%-30%, that would have a huge impact on the ability to even make the purchase or cause a significant delay in the acquisition.
One, two or even three years is just not enough time to invest in assets with risk. If things don’t work out well, there is just not enough time to recoup the losses. Keep in mind that when pundits are out there preaching historical market returns of 9%-11%, that’s based on many decades of data, not a few months’ worth. Much to my chagrin, I have met couples who didn’t take my advice and instead invested their down-payment money and, needless to say, are still waiting to buy their first home.
What to do?
There isn’t too much to do. For investors holding US dollars, certificates of deposit (CDs) are the best choice. They are insured by the US government and pay some small amount of interest. While CD rates can change, one- to two-year deposits are yielding approximately 1.5%-1.9% annually. Not great, but better than nothing, and the money is government insured. Short-term US government bonds are also an option, but they tend to have lower yields than their CD counterparts.
Similarly, for Israeli shekel-based investors, both short-term deposits and/or government bonds are also an option. However, for locals there is one more variation that I recommend investigating. The big problem with leaving money in money markets or in shortterm bonds or deposits is that the returns can be lower than inflation. This means that in two years when you buy your home, the purchasing value of your money will be less than it is today. If inflation is running at 2% and you are making anywhere from 0% to less than 2%, you are actually losing money in real terms.
The way to protect the future purchasing power of your money is through inflation-linked securities. While these investments do exist in the US, Israel, due to rampant inflation that existed pre-Bank of Israel governor Jacob Frenkel, has a very developed inflation-linked market. Whether by investing in individual Israeli government bonds linked to inflation or even tochniot chisahon ( bank savings plans) linked to inflation, investors can go most if not all the way in protecting the value of their money.
I specifically used the word “individual” when mentioning Israeli government inflation-linked bonds. The reason is because if you go to the bank and ask, they will probably try and sell you a mutual fund that invests in a basket of them. This can be problematic for two reasons:
No. 1 – PFIC (passive foreign investment company). If the investor is an American citizen, this can be very costly both tax-wise and having an accountant do the filing for you, and it will most probably end up costing you way more than you will make in interest.
No. 2 – Not guaranteed. As I have mentioned before, when investing in mutual funds, the fund is valued based on the current market value of all the securities it holds. As such, if the value of inflation-linked bonds drops, the value of the fund will drop as well. By purchasing an individual bond, if you hold it until it matures, you will succeed in protecting the value of your money.
It can be frustrating watching your money sit and not grow in value. Don’t risk your money. Be patient and remember the goal for this money is to buy a home in a defined short-term time period.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc., or its affiliates.
aaron@lighthousecapital.co.il