Have you ever been in a situation where you had a big chunk of money that you felt you had to “do something with”, even though you have big plans for it in the very near term?
It’s actually not uncommon, especially since risk-free investments pay practically nothing in interest.
It only seems natural to want to somehow invest it and make it grow – at least a little.
Teresa M. of Florida is facing this dilemma right now and sent the following question:
“I am over 62 years old. I plan on working until 67. At work I have a 401K that I have been investing in for 6 years now. In the next couple weeks I will inherit approximately $25,000. I would like to put it in a short time investment while I look for a new home. My question: Would it be a good idea to put all, or some, of that money in the 401K I already have going? Or pick another avenue that I can easily pull that money out when I get ready to purchase a home.”
Everyone’s situation is a little bit different, so I’ll try to answer Teresa’s question directly, while also providing plenty of other considerations for anyone else in this position.
Short-term means Short-term So Keep it Simple
If you you want to invest money short-term, you have to specifically define how long that will be. The timeframe will play a major role in how you will invest the money, or if you will invest it at all. For some people, “short-term” might be five years. For others it might be two or three. In general though, I think we can agree that short-term is anything less than one year. But whatever the length of time, it will matter.
It looks as if Teresa is planning to start the house hunt pretty quickly. That being the case, she shouldn’t want to get complicated with the money. She could find the perfect house in a month, or in six months. That’s how it works when you’re shopping for a home, the right house shows up, and it’s time to get moving.
For that reason, access to the money will be more important than the return that Teresa might get on it. She shouldn’t want to put the money anywhere where she couldn’t get to it on very short notice. Most real estate transactions require that you put up a purchase deposit upon signing the contract. In some states, you are required to have a certain percentage of the sale price held in escrow as an earnest money deposit.
This will usually amount to several thousand dollars, and will have to be immediately available. In addition, there will be other expenses, such as a mortgage application fee, a home inspection fee, and the cost of a homeowners insurance policy. Additional cash will be need to be available to cover those costs.
There are really no investments with a decent return that can be liquidated that quickly, and without the potential for the loss of some principle value.
The 401(k) Option
Teresa mentions the 401(k) option, which is worth discussing. Since she’s in her early 60s, and has only been participating in the plan for six years, building up that plan might be an excellent strategy.
But since a 401(k) plan is funded out of earned income, she won’t be able to make a direct transfer of the money into the plan. What she could do however is contribute a higher percentage of her paycheck into the 401(k), and use the inheritance money to make up the shortfall in her income. That would create a backdoor transfer of the inheritance money into the retirement plan.
Of course, if she wants to put all of the inheritance in the 401(k), that would take purchasing a home out of consideration. But that can be an excellent strategy if her primary intention is to shore up her retirement plan.
She could consider a split, in which some money goes into the 401(k), and the rest is used for a down payment on a house. This will depend entirely upon the purchase price of the home, the amount of the down payment she plans to make, and what other financial resources she has to help with the down payment.
Teresa, you’re going have to do some serious soul-searching and evaluation of your entire financial situation in deciding exactly how to do this. Without knowing your whole financial picture, I’m not in a position to give specific advice here.
One note of caution here Teresa – any money you put into a 401(k) is money that you will not be able to pull out quickly for the purchase of a home. This is mostly going to be an either/or choice; either you will put money into a 401(k), or you won’t. Pulling it out will require the payment of ordinary income taxes, and that will further reduce the amount of money you have available for a down payment.
It’s Short-term Money – You Can’t Take Risks
Since we know that Teresa is likely to have an immediate need for the money, her only reasonable investment options are those that are super safe. That means no stocks, bonds, mutual funds, exchange traded funds, real estate investment trusts, or any investments that fluctuate in value.
Is she puts her money into any of these instruments, and they fall in value by say 10% over the next six months, she’ll have that much less money for the down payment. But even worse, if she’s forced to sell investments in order to make the down payment, she will lock in the loss on that investment permanently.
Yes, it could go the other way – the investment could go up by 10%, in which case Teresa would come out ahead. But when you’re in a position where you need the money now, that almost never happens. More likely, Teresa will lose money by doing that.
Where SHOULD You Invest the Money While Looking For a Home?
Okay, we know where Teresa should not invest the money, so what are the best places left?
Basically, it’s any investment that:
- Protects the principal value of her investment,
- Pays at least a little bit of interest,
- And is completely liquid
That limits her investment choices to cash and cash equivalents. The best choices are either an interest-bearing savings account or money market funds. You can get either at your local bank or credit union, the investment principle is completely safe, they do pay a little bit of interest, and when you need the money all you have to do is go to the bank and withdraw it.
Since Teresa is looking to buy a house, she should avoid interest-bearing investments that might tie up her money for a few months. For example, certificates of deposit will generally pay more interest than either a savings account or money market fund, but if you have to withdraw the money before certificate matures, you’ll have to pay an early withdrawal penalty.
Keep it safe, keep it liquid, and you’ll have when you need it.
The Home You Buy Will Be the Ultimate Investment
There may be a thought here that keeping the money invested in short-term, low interest paying investments is no way to grow your money. And that’s true! But that’s also not your objective. What you’re really looking for is a place to park your money where it will be safe until it is needed.
The real investment here is the purchase of the home. Once Teresa has the home, she will also have an investment. She stands to gain on that from a combination of appreciation on the home, and the gradual pay down of her mortgage.
But take heart Teresa, that will almost certainly end up being a better investment than any that you can make between now and the time that you are ready to make the down payment. You’ve asked all the right questions, so I’m confident that you’ll do the right thing with the money. Good luck!
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