Saving for down payment in roughly 5 years

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Saving for down payment in roughly 5 years

Post by Shinplaster »

I have some money in my TFSA that I want to allocate towards a downpayment in 5 years. I don't want it to be too risky, but wouldn't mind a dividend. Do you have any suggestions?
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Re: Saving for down payment in roughly 5 years

Post by Peculiar_Investor »

My standard answer to this type of question is the quote "return of capital is more important than return on capital."* (my underline).

Since this is for a future down payment and therefore an exact amount to be available is not required, I'd soften that a bit to make sure that make sure you understand the implications of a sequence of bad returns should the markets move against you at the wrong time. Imagine for a moment if you'd taken this line of thought in 2002-03 with full knowledge of the financial crisis that would happen in 2007-08. Or 1995 knowing about the dot com bust. Would you be able to defer the decision to buy, or change your goal, or tap into other source of funds should a shortfall from your planned amount arise?

*Often attributed to Will Rogers, but in reality misattributed.
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Re: Saving for down payment in roughly 5 years

Post by longinvest »

The thing is that it's pretty difficult to anticipate now the cost of the house that will be bought in 5 years. Or, maybe the OP will change his mind and decide not to buy in 5 years for some good reason at that point.

Personally, I would just invest the money into a balanced portfolio (something between 60/40 stocks/bonds and 40/60 stocks/bonds), being completely aware that a balanced portfolio fluctuates in value, as do houses.
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Re: Saving for down payment in roughly 5 years

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longinvest wrote: 11 Dec 2017 17:54
Personally, I would just invest the money into a balanced portfolio (something between 60/40 stocks/bonds and 40/60 stocks/bonds), being completely aware that a balanced portfolio fluctuates in value, as do houses.
So would I. Yes, there is some risk, but from the little you have said, I think it's manageable, i.e. you should be able to recover nicely from any bad luck. At worst, you might have to postpone your purchase.

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Re: Saving for down payment in roughly 5 years

Post by Quebec »

longinvest wrote: 11 Dec 2017 17:54 Personally, I would just invest the money into a balanced portfolio (something between 60/40 stocks/bonds and 40/60 stocks/bonds), being completely aware that a balanced portfolio fluctuates in value, as do houses.
Personally, I would do 10-40% stocks for an horizon of 5 years. And maybe reduce this to 0-20% stocks with, say, 2 years to go to the purchase date.

That way, the OP does not have to pray the market gods that his/her money will be there when needed. It will, and hopefully the after-inflation return will be slightly positive.

I.e., a P_I writes, "return of capital is more important than return on capital" for relatively short term investments.
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Re: Saving for down payment in roughly 5 years

Post by Peculiar_Investor »

longinvest wrote: 11 Dec 2017 17:54 The thing is that it's pretty difficult to anticipate now the cost of the house that will be bought in 5 years.
That depends on where the OP intends to purchase a house. Many regions of Canada have fairly stable and somewhat predictable housing prices. The headlines of course only want to talk about the Toronto and Vancouver regions where house prices are nowhere near stable or predictable.

Another thought of the OP to consider if they choose to invest their down payment funds into the equity market, perhaps they might choose something that tracks or shows correlation to the housing market as their investment vehicle. For example, would REITs offer some level of correlation that might protect the sequence of returns risk?
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Re: Saving for down payment in roughly 5 years

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Peculiar_Investor wrote: 11 Dec 2017 18:25Another thought of the OP to consider if they choose to invest their down payment funds into the equity market, perhaps they might choose something that tracks or shows correlation to the housing market as their investment vehicle. For example, would REITs offer some level of correlation that might protect the sequence of returns risk?
This is a good idea, and like you say, it would depend on the REIT correlation to the market they are targeting. BTW if their target market should suffer a reversal of trend, so would the REIT.
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Re: Saving for down payment in roughly 5 years

Post by AltaRed »

Not sure how well REITs would correlate to house prices. The residential rental REITs don't necessarily correlate to house prices but I suspect they are the most likely bet, e.g. CAR.UN or BEI.UN depending on location. Bottom line: There is no way to seek moderate return on capital without having risk of capital.

Sad to say, but if a down payment is is planned for 5+ years, a 5 year GIC in a TFSA from one of the online banks is as good as it gets, with safety. We are entering a new world of increasing interest rates and we don't know if the overnight rates are going up 50 bp/year, 100 bp/year or? Nor do we know how that will affect the 1-10 year yield curve, and thus the impact of the headwind on both FI and equities. A balanced fund may be a bad choice.

That said, if those kinds of interest rate hikes ARE likely to happen, it is likely to have a significant effect on house prices as debt laden consumers risk foreclosure on significant changes in their mortgage servicing costs, or simply cannot afford to buy....period. Maybe there really will be a Housing Bust 2018 and beyond.
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Re: Saving for down payment in roughly 5 years

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AltaRed wrote: 12 Dec 2017 10:18 Not sure how well REITs would correlate to house prices. The residential rental REITs don't necessarily correlate to house prices but I suspect they are the most likely bet, e.g. CAR.UN or BEI.UN depending on location. Bottom line: There is no way to seek moderate return on capital without having risk of capital.
Completely agree. I offered up the REIT suggestion as something that the OP might want to study/review in case they don't want to go down the GIC/savings account route to accomplish their objective.
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Re: Saving for down payment in roughly 5 years

Post by Koogie »

OP doesn't mention the kind of return they are looking for. A 5 year time frame would give them a GIC return of 3% at current rates (a little more compounded). 5 years is a long enough time to probably not waste it in GICs though.
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Re: Saving for down payment in roughly 5 years

Post by Peculiar_Investor »

During my dog walk this morning I got thinking further about this and I started to look at it from another perspective.
longinvest wrote: 11 Dec 2017 17:54 The thing is that it's pretty difficult to anticipate now the cost of the house that will be bought in 5 years.
I would agree, so I wouldn't bother trying to figure it out. But there are other things that can be figured out with some degree of certainty.

The "relatively" known items involved here are:
  1. in roughly five years the OP has determined a down payment amount as an objective and likely is saving towards it. Base on the original post, they want to earn some level of return on this investment.
  2. he/she can also probably estimate how much mortgage they will be able to afford when the time to purchase comes, based on current income levels and a conservative estimate of what mortgage rates could look like in roughly five years
Armed with both those pieces of information, he/she can therefore determine how much house they will be able to afford and comfortably carry. A prudent buyer would only purchase to the level they can comfortably afford, rather than stretching themselves and having no safety net should things not work out as planned. They will have to deal with whatever has happened to house prices in their desired location/region when the time comes. That's unfortunately not in their control.

If a guaranteed return on their down payment money over the next five years won't provide the necessary amount to make it work, then I would suggest the prudent step would be to look for opportunities to save more rather than take on riskier investments with the hope of growing the down payment money in the next five years. Reaching for yield or additional return over a short timeframe generally doesn't turn out well.
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Re: Saving for down payment in roughly 5 years

Post by longinvest »

Peculiar_Investor,
Peculiar_Investor wrote: 12 Dec 2017 13:46 If a guaranteed return on their down payment money over the next five years won't provide the necessary amount to make it work, then I would suggest the prudent step would be to look for opportunities to save more rather than take on riskier investments with the hope of growing the down payment money in the next five years. Reaching for yield or additional return over a short timeframe generally doesn't turn out well.
If we want to apply this reasoning to house buying, we should also apply it to retirement funding, car funding, and whatever. In other words, let's invest 100% of our essential retirement money in liability-matched Real Return Bonds (RRBs), so that we can get a guaranteed rate of return. Except that this is mostly impractical and, most often, impossible. For one thing, RRBs have their maturities spread 3 to 5 years apart and mature way before the end of our entire retirement horizon. For another, we don't know the reinvestment yields for coupons paid between now and the need for the money. Also, we just don't know exactly how much we'll need on each year of retirement. We don't even know on which year our car will start requiring too many repairs and we'll need to replace it (let alone the price of the car we'll choose as replacement). I could go on and on.

I've resolved to have a simple and flexible financial life. I've got enough cash, in my chequing and high-interest savings account, to pay for upcoming expenses and credit card statements (in full), and the rest is invested into a 50/50 stocks/bonds portfolio spread across RRSP, TFSA, and non-registered accounts at a discount broker. When we decided to buy a car, this last year, we just withdrew the money from our portfolio and paid it cash. That was it. We didn't maintain a separate non-rolling CD ladder maturing on an exact date to buy a new car. We bought the car when (1) we felt like it and (2) we had enough money in the portfolio to pay for it.

As I said, if it was me, I would just invest the money into my 50/50 portfolio and evaluate the situation in 5 years. If house prices are down and the portfolio up at that point, there will be more choices than if house prices are up and the portfolio is down. Such is life.
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Re: Saving for down payment in roughly 5 years

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longinvest wrote: 12 Dec 2017 14:08 Peculiar_Investor,
Peculiar_Investor wrote: 12 Dec 2017 13:46 If a guaranteed return on their down payment money over the next five years won't provide the necessary amount to make it work, then I would suggest the prudent step would be to look for opportunities to save more rather than take on riskier investments with the hope of growing the down payment money in the next five years. Reaching for yield or additional return over a short timeframe generally doesn't turn out well.
If we want to apply this reasoning to house buying, we should also apply it to retirement funding, car funding, and whatever. In other words, let's invest 100% of our essential retirement money in liability-matched Real Return Bonds (RRBs), so that we can get a guaranteed rate of return. Except that this is mostly impractical and, most often, impossible.
A see an important difference between saving for a down payment in roughly five years and retirement planning and that is the timeframe. History shows us that over longer timeframes, equities generally outperform fixed income. But that doesn't hold true over short timeframes such as the OP's roughly five years.

There is a specific objective here, to have an appropriate down payment to purchase a house in roughly five years. I would not subject these funds to Mr. Market, particularly for what I'm guessing would be a first time home buyer. For most Canadians, a home purchase is there biggest investment and they may not have any investment portfolio to consider.

Once you achieve some level of financial freedom, then you become more engaged in planning and funding your retirement. Then much of your suggestions become the standard operating procedure. But I'd hazard a guess that describes the majority of FWF'ers, particularly those who have been around for a while. It may or may not apply to the OP, so I'm suggesting taking the more conservative (and conventional) route.
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Re: Saving for down payment in roughly 5 years

Post by big easy »

I think the same logic applies to RESPs. When my kids entered high school I started transitioning the equities to fixed income. By grade 12 there will be no equities. You could do something similar with the house fund.

Added: I guess it depends on whether you have a fixed date in mind or you can continue to invest until you have your required nest egg.
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Re: Saving for down payment in roughly 5 years

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Peculiar_Investor,
Peculiar_Investor wrote: 12 Dec 2017 14:21 There is a specific objective here, to have an appropriate down payment to purchase a house in roughly five years. I would not subject these funds to Mr. Market, particularly for what I'm guessing would be a first time home buyer. For most Canadians, a home purchase is there biggest investment and they may not have any investment portfolio to consider.
To clarify:
  1. I really think that nobody knows what house prices will be 5 years from now. As a consequence, I consider that the objective isn't specific.
  2. I would only expose part of my own money to Mr. Market by investing into a balanced portfolio (a portfolio with 40% to 60% invested into bonds).

The OP is free to do with his money as he wishes. He asked for suggestions; I gave an indirect answer by telling him about how I manage my money and I replied to your posts to further explain my motivations for how I do it.

To tell the truth, I do think that your view is reasonable, but it isn't how I view the management of my own money.
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Re: Saving for down payment in roughly 5 years

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We don't have many details from the OP. But I see a big difference between purchasing a big item like a house and saving for retirement. The purchase of a house can always be delayed, if it turns out that the markets are down at the planned date. Renting for another year or two may not be what the OP would like, but it would be unlikely to threaten his lifestyle.

By contrast, most people have less flexibility with a planned retirement date. In some cases, one can choose to work longer if markets are unsatisfactory, but that is not always an option. Even if it is an option, the impact on one's enjoyment of life is likely to be bigger than the inconvenience of postponing the purchase of a house for a couple of years.

I conclude that most people can afford to take more risk with a down payment than with one's retirement funds. (I say this as someone who originally retired in 1999 with most of his retirement portfolio in tech stocks.)

Of course, it may be that I am less risk averse than most posters here. But life is full of risks, and most of us are far more resilient than we imagine. I find it sad to see young people "playing it safe" with their money. That doesn't mean they should take big risks. But it seems to me that some equities, e.g. through a widely diversified index fund, are quite prudent within a five year horizon. That is why I endorsed longinvest's proposal of a 50/50 allocation.

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Re: Saving for down payment in roughly 5 years

Post by longinvest »

ghariton wrote: 12 Dec 2017 20:50 life is full of risks, and most of us are far more resilient than we imagine.
+1 :thumbsup:
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Re: Saving for down payment in roughly 5 years

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longinvest wrote: 12 Dec 2017 22:44
ghariton wrote: 12 Dec 2017 20:50life is full of risks, and most of us are far more resilient than we imagine.
+1 :thumbsup:
+2 :thumbsup: :thumbsup:
What never ceases to amaze me is how 2000 created an experience that profoundly influences George now, 17 years later. Thanks for reminding us.
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Re: Saving for down payment in roughly 5 years

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ghariton wrote: 12 Dec 2017 20:50 I find it sad to see young people "playing it safe" with their money.
Here is how we do it:
- ''Five year old Corolla'' buying fund, to be used in 0-3 years, about 50% funded at this stage: 100% HISA
- Emergency fund, to be used at any time: 100% HISA
- ''Small losses'' fund (self-insurance reserve), to be used at any time: 100% HISA
- RESP, to be used relatively quickly, starting in 11-12 years: 50% stocks, 50% bonds (on a steep glide path towards 0% stocks)
- Retirement accounts, to be used slowly, starting in 15-20 years: 70% equities, 30% fixed income (on a gentle glide path towards 50% equities)

By far most of our liquid assets are in the retirement accounts (RRSP, TFSA, wife's non-reg). So if we add up everything, we are not ''playing it safe''. But I think it makes sense, when you have a specific relatively short term objective like the OP, to play it safe with that particular account.
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Re: Saving for down payment in roughly 5 years

Post by deaddog »

At 20 some years old you can afford to take a lot of risk.

I would go 100% equities with an exit strategy that protects your capital.

You are investing inside a TFSA so can afford to move in and out of the market without tax consequences.

An excellent opportunity to learn about the market and about yourself.
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Re: Saving for down payment in roughly 5 years

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Quebec,
Quebec wrote: 13 Dec 2017 09:04 Here is how we do it:
- ''Five year old Corolla'' buying fund, to be used in 0-3 years, about 50% funded at this stage: 100% HISA
- Emergency fund, to be used at any time: 100% HISA
- ''Small losses'' fund (self-insurance reserve), to be used at any time: 100% HISA
- RESP, to be used relatively quickly, starting in 11-12 years: 50% stocks, 50% bonds (on a steep glide path towards 0% stocks)
- Retirement accounts, to be used slowly, starting in 15-20 years: 70% equities, 30% fixed income (on a gentle glide path towards 50% equities)

By far most of our liquid assets are in the retirement accounts (RRSP, TFSA, wife's non-reg). So if we add up everything, we are not ''playing it safe''. But I think it makes sense, when you have a specific relatively short term objective like the OP, to play it safe with that particular account.
Wouldn't that sum up to, more or less, an overall 50/50 portfolio?

I've realized a while ago that a 50/50 portfolio matches more or less my different needs. Instead of having, for example, a retirement portfolio with $70,000 in stocks and $30,000 in bonds, and a $40,000 emergency fund on the side, I could have a $140,000 50/50 portfolio spread tax-efficiently across accounts, putting bonds into RRSP/RESP/... in priority. I just need to keep enough of the portfolio invested into an account that lets me withdraw the money without losing contribution space, like a TFSA, to take care of emergencies. It's OK to sell some stocks in the TFSA and withdraw the money, then sell some bonds to buy stocks in the RRSP, to bring back the overall portfolio to its target 50/50 allocation.

The only two exceptions, where I do mental accounting, are:
1- I don't consider cash as part of my portfolio. The amount of cash I keep in my savings and chequing accounts is determined by planned upcoming expenses and the current balance of my credit cards (so that I can pay them in full).
2- I don't consider a non-rolling GIC or RRB ladder delivering a stable stream of payments as part of a bond allocation. I consider it as a time-limited predetermined income stream (a build-it-yourself term-certain annuity).

Cash is critical for my day-to-day financial life and has to provide me with specific amounts of money exactly when needed.

Time-limited and lifelong income streams are retirement tools for me (along with withdrawals from a portfolio). A time-limited predetermined income stream is quite useful to fill the gap between retirement and the start of a pension (such as CPP or OAS).

I don't plan to buy income streams before I retire. So, even if I decide to delay CPP and OAS, I won't be building any bridging ladder (or buying a bridging term-certain inflation-indexed annuity, instead, if priced competitively) until a few months before I retire.

For now, as I'm in accumulation mode, I just keep (1) cash and (2) a balanced portfolio spread across registered and non-registered accounts. I keep no other mental divisions in my money. Of course, I can use a spreadsheet build a plan and try to attribute any part of my today's overall portfolio balance to whatever part of the plan I want. The bigger the portfolio becomes, the more freedom I get to reshuffle the plan. But, I don't let these spreadsheet games affect the 50/50 allocation of my portfolio. When the portfolio balance changes, I just let the spreadsheet refresh its plan based on the new balance.

By the end of the day, if the overall portfolio is down, I'm poorer. If I overpay for college, just because "college money" didn't drop and I thus "have the money for paying such a big tuition amount", but on the side of this most of the stocks I hold in my 100% stocks "retirement portfolio" are bankrupt, then I am making a pretty poor financial choice. I would make a better choice by looking at the overall portfolio size and decide how much I can actually afford to spend on college tuition, given my current financial situation, regardless of the RESP balance.

It's just how I see things for me.
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Re: Saving for down payment in roughly 5 years

Post by ghariton »

longinvest wrote: 13 Dec 2017 18:51 It's just how I see things for me.
I do pretty much as you do. The only significant difference that I can see is that I do my asset allocation in terms of absolute amounts instead of percentages.

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Re: Saving for down payment in roughly 5 years

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longinvest wrote: 13 Dec 2017 18:51 Wouldn't that sum up to, more or less, an overall 50/50 portfolio?
More or less, at the moment, if you include cash. But ten years ago, we had accumulated a substantial house downpayment, which a few months before the house purchase, was all in cash. At that stage, the retirement portfolio was worth a lot less than it is now. So 10 years ago, our overall asset mix was strongly tilted towards cash relative to the current situation, because our overall ''goal mix'' was quite different than it is now. We had shorter term priorities.

Of course, if you exclude cash from the calculation, then our asset mix was more aggressive than it is today, not less.

Anyway, my point is, for the OP, don't gamble with a house downpayment.

I was strongly influenced by a personal experience where in my twenties, I eventually found myself short on cash to pay for food and rent (I was studying in a foreign country and I wasn't allowed to work). The only non-RRSP funds I had left at this stage had been stupidly invested in a stock-heavy (maybe 70-80% stocks) mutual fund, which happened to be down a lot. I had chosen this particular fund because ''I was young and could afford the risk''. I thought I wouldn't need this money for a while, but then I did. And a significant part of the money wasn't there anymore. So I checked the account balance regularly and nervously watched it climb back, luckily, near pre-crash levels, where I sold everything since I had to eat. This thought me not to buy stocks with money I might need soon.

I'm just sharing this story to show longinvest where I'm coming from with my division of liquid(ish) assets into 5 pots with different objectives, horizons and asset allocations. The overall asset mix of all 'pots' combined is not fixed in time, because goals change.
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Re: Saving for down payment in roughly 5 years

Post by JaydoubleU »

Great discussion.

Inspired, I went to have a look at TDB8150. 0.95% interest, before tax. After inflation, I would assume the return is actually negative. I am wondering where the safety is in this?

I understand the risk of stocks, but wouldnt some low volatility dividend stocks get you a much better return for only slightly more risk? Emera, for instance, has a negative beta of -.011, according to globeinvestor. Then you get a 4.81% yield, which has grown by 8.13% and 12.29% per year, over one and five year period, respectively.

OK, there is interest rate risk, above all. I really question whether rates will rise as much as feared--central banks want to manage inflation, but they dont want to crush economic growth.

If the OP had suggested 0-2 years, that would be another matter, but 5 years! In 5 years time, cash plus 1% may have lost purchasing power. That to me is a risk worth considering.
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Re: Saving for down payment in roughly 5 years

Post by Quebec »

JaydoubleU wrote: 30 Dec 2017 08:54 Inspired, I went to have a look at TDB8150. 0.95% interest, before tax.
My discount broker lists a few 5 year GICs at 2.8%.
EQ bank currently offers 2.3% on a HISA according to Comparison chart | Canadian High Interest Savings Bank Accounts.
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