Hello and welcome to another episode of Ask Marco where I answer your investing related questions.
Today’s question comes from Armen and he says, hi Marco, I’m a long-time listener. Thanks for all that you’ve done with your podcast. I have a question about how to efficiently invest my money that I am saving for a down payment. I allocate a chunk of each paycheck to saving for a rental property down payment and I was wondering what you think is the most efficient way to invest that money such as CD’s, T-bills, or just in a regular brokerage account in stocks. I’ve been doing a lot of research and I can’t decide what is best. Thanks so much! – Arman
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So, Arman, that’s a good question. I guess you have to look at the time horizon. Are you saving with the intention of deploying these funds in a relatively short period of time, let’s say 90 days or less? Or are you saving at a pace where you won’t need the funds for let’s say a year or more?
That could make a a difference in how you actually save the funds. So if you need the funds to be fairly liquid, then you’ll want to put them in what are essentially referred to as cash equivalents. And these are typically investments that have short term maturities of less than 90 days and they’re considered very liquid because they can be readily converted to cash. And so common examples are things like stocks and marketable securities, things that are publicly traded and easy to get in and out of us. Treasuries and bonds mutual funds are typically less volatile than stocks. And so they probably, and possibly can give you a better return than just putting it into, let’s say US treasury or a bond. But then of course there are money market funds and this is a type of mutual fund that invest in very low risk, low yielding investments like municipal bonds.
So it’s similar to a mutual fund and a money market fund and they’re very liquid. So these are the types of things that are very liquid but produce very little in terms of a rate of return. In fact, some of these are so low, you know, it could be half percent one, 2% in terms of rates of return that you’re actually losing money when you factor in the real rate of inflation. So if inflation is like 3% 4% 5% whatever number you want to believe, but you’re getting a 1% return on your, your savings, your cash, you’re actually losing money. Now is this a big deal? Possibly not. If you need the funds right away or in a relatively short period of time, this is not going to make or break anybody. So it’s not that big of a deal. Uh, so if you need them liquid and in a short period of time, 90 days or less, cash equivalent is probably the best place to keep it.
A savings account. You don’t get anything from a savings account, but it’s just there. So it’s easily easy to access. Now, if you’re talking about a time horizon that is more than a year and less than five years, that’s what you might define as a short term investment. So there’s no formal definition or official definition of what that means, but essentially short term means one to five years and if that’s what you’re looking to do, then there are various options out there depending on your comfort level. I mean, I’m not a big fan of the stock market. There’s a lot of volatility, but of course, you could park it in an ETF or an index fund, which is relatively stable, but it does fluctuate from year to year depending on what the market’s doing. And let’s face it, we’ve seen years where we’ve seen big drops in terms of the overall market.
So that’s why it’s not a favorite place for my, you know, my cash. If I’m going to just park cash for a short period of time, I’m okay with keeping it in an FDC insured account and the bank knowing that it’s just there for the purposes of safety, liquidity and easy access and deployment. But if you’re looking for higher rates of returns, you’re going to have to look at some, you know, alternative investments there. Are there various types of savings accounts. Municipal bonds probably offer higher potential returns and some tax advantages. But the problem with that is there is the potential for loss. They’re not ideal for those in lower tax brackets. And of course, you know, the interest earned on bonds is taxed. So there are capital gains. Short term bonds is another option. Now when it comes to municipal bonds, there’s a significant downside to bonds and that is taxes because interest earned on bonds are taxed as is any capital gain.
However, there is one option with bonds that reduce the tax burden and that’s with municipal bonds and some people refer to them as munies. So these bonds are typically free, a federal income tax and may actually be free of state income tax too. So municipal bonds or Munis are an excellent option if you’re looking for a higher rate of return. Keeping in mind that there is some risk and especially if you’re in a higher federal tax bracket, this might be a good option because you’re not going to be taxed on it at the higher tax rate that you’re at. So the pros with a municipal bond is that there’s the potential for higher returns. There are tax advantages and it’s easy to access the funds without having a penalty. The drawback of municipal bonds is that there is the potential for loss because you are essentially investing in debt.
You are lending your money to a local government or municipality. It’s not ideal for those in lower tax brackets because there’s no tax favored treatment with those. But the expected of return after tax in most cases with muni bonds is anywhere from two to four maybe 5% and that’s good in the sense that it keeps up with inflation or maybe even beats inflation by a small margin. So if you’re looking at something that’s 6 to 12 months in terms of how long you want to save your money before accessing it or maybe a little longer, that might be an option. I am not a big fan of a lot of these savings vehicles or investment vehicles. If I need my funds in three months, six months, 12 months, I, like I said before, just we’ll park it in a savings account. I’ll take that 0.5% if that in terms of a savings rate because I know I’m just going to redeploy those funds into something that is a much, much better opportunity for me.
So let’s summarize where the best investments for short term money might be. If you need your money in a year or less, your ideal investment auctions are a savings or money market account and a cash management account. What you could stand to gain from these in terms of an interest rate is about one and a half to 2% or more. If you go with some of the online banks that are out there, but a savings account is really the most liquid type of account but don’t expect to get much at all. The risk with that is that there is no risk or very low risk and you know, the accounts are actually backed by the FTC for whatever that’s worth. So it’s a very low-risk way to keep your funds liquid. If you need the money parked away for let’s say two to three years, your best investment options are probably going to be treasuries, bond funds and CDs, certificates of deposit and your potential interest rate there is probably around 2% two to 3%.
So it’s a little bit better than um, you know, savings and money market accounts. The risk there if you will, is that these are bank products and consider it safe. Treasuries are considered safe, but uh, but if you get into corporate bonds, you know, those are slightly less so in terms of, um, safety and then, you know, I don’t think you’re thinking about three to five years or even more. But if that’s the case, if you’re thinking like three years out, your best investment options for parking, that cash that I don’t consider really a good investment is again, your CDs, bonds, bond funds and possibly some stocks for longer periods of times or at least some ETFs and doing that. The potential return on that is about two and a half percent or more. And again, you know, I say potential because it could be a lot more in the stock market, especially looking at the last several years.
That’s just history. But that is no guarantee that you’re going to continue to see that rate of return for the next 3 months, 6 months, 12 months. Are there risks in that? Certainly, you know, much higher risk because you have a lot of volatility and fluctuation. Uh, CDs and bonds are relatively low risk compared to stocks, which obviously fluctuate a lot. So hopefully that will give you some perspective. But you know, just ask yourself, how much is liquidity important to you versus getting, uh, any kind of rate of return. If it’s very short term, you should focus on the liquidity. Not so much the rate of return.
All right. I hope that helps. That’s it for today. If you have any questions, you know, just go to passiverealestateinvesting.com click on the ask Marco button. Submit your question. Happy to answer. Remember to subscribe, share the show with likeminded people. Visit us on iTunes and leave us a rating and review. Thanks again for listening and we’ll see you on the next episode.
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