We have a potentially lucrative investment opportunity on the horizon. It will take an aggressive savings strategy to be able to jump on it. So, I wanted to walk through our thought process on how we plan to attack this ambitious short term savings goal.
I recently learned that I may have an opportunity to make a work-related investment sometime in the next year or two. At this point, I have little detail on what this opportunity may be worth or even a good handle on the purchase price. I figure I will drive into the details in a separate post once that information is available. While, there is no guarantee this opportunity will come to pass, the information I have received suggest it will require a sizable financial contribution.
Two things are clear:
1. We will need to build up a sizeable war chest
2. We will need to do so rather quickly
We need to develop a savings approach to ensure we are financially ready if (when?) the time comes. One of the largest challenges we face is that we do not know the exact timing. Our savings window may be 3 months or 3 years. My gut says about a year or two, but who really knows.
Our “Standard” Strategy
Our usual savings strategy is really focused on long term goals and is pretty simple. Boring really. We are invested in low fee index funds, primarily total stock market funds with a smattering of total bond index funds. Most of our contributions currently come from our employer-sponsored 401k plans.
This equity-dominated approach will likely serve us well for the long-term as we have time to ride out any market drops. But what about shorter-term goals like the one we currently are considering.
So what exactly are our options? What are the Pros and Cons of each? And ultimately, what are we going do?
Options, Options, Options
Certificates of Deposit
Certificates of Deposit (CDs) are promissory notes from a bank that pay you interest during the allotted time period. A CD is insurable by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per individual.
- Pros:
- They are very safe and you are guaranteed your interest payment.
- Cons:
- The funds cannot be withdrawn before the maturity date without incurring a penalty.
- The interest rates can be rather low in comparison with other options. At the time of this post, the rates on 2-year CDs averages about 2.5%.
Equities (Stocks, Mutual Funds, Index Funds, and ETFs)
Equities allow you to buy an interest in a company. You can earn money by selling shares when prices are higher and through dividends (money paid to share holders by companies out of their profits).
- Pros:
- Equities have the potential for large gains in value.
- Cons:
- They also are susceptible to sudden and large drops in value.
- Equities are not FDIC insured.
Bonds
A bond is essentially a loan you give to a government entity or corporation. The amount you loan is the principle (otherwise known as the bond’s face value or par value). In return you are paid a certain interest rate (coupon rate). In addition, when you sell the bond you may also profit from higher bond prices at the time of the sale.
- Pros:
- Returns are typically higher than CDs.
- With high quality bonds (rated BBB or better), the risk of default (failure of the corporation to repay the debt) is low.
- Risk is less than equities.
- You can sell bonds before they mature, which makes them more liquid than CDs.
- Cons:
- Bonds are more volatile than CDs and are not FDIC insured.
- Some bonds are “callable” which means the issuer can redeem the bond. This typically happens when interest rates drop, which means an investor would likely face a reduced return due to having to repurchase bonds with a lower interest.
T-Bills
Treasury Bills (T-Bills) are similar to bonds. They are issued by the government and typically have a maturity period of less than a year. You buy a T-Bill at a discount from its face value. You receive the interest (the difference between the purchase price and the face value) when the T-Bill matures, rather than receiving periodic interest payments like for a bond.
- Pros:
- Short maturity periods keep your money tied up for shorter periods.
- T-Bills are backed by the U.S. government and are essentially risk-free.
- Can be purchased in low dollar amounts (as low as $100), which makes them more accessible than other equities.
- Cons:
- Even though your money is tied up for a shorter period of time, it is not liquid.
- Returns are typically lower than CDs and may barely keep pace with inflation.
Savings Account
Just your everyday plain Jane interest-bearing bank account. You can deposit and withdraw money almost at will; however, some money market savings accounts have a cap on monthly transactions.
- Pros:
- The most liquid savings option (short of stuffing cash under your mattress); therefore, its ready whenever you need it.
- Your savings are not subject to market conditions and are essentially zero risk.
- Some online savings accounts can offer interest rates on par with CDs.
- Savings accounts should also be FDIC insured.
- Cons:
- Lower potential returns than most other options, which may not keep up with inflation.
401k Loan or Home Equity Line of Credit?
In a crunch we could borrow from our 401k funds or apply for an equity line of credit. A 401k loan allows you to rob your retirement account. You then have to repay yourself, with interest, in typically 5 years or less. A home equity line of credit (HELOC) allows you to borrow a portion of the equity in your house. This money is then paid back, with interest, to the lender.
- Pros:
- If the need presents itself before the necessary funds are saved (or if market conditions have decreased their value) then a loan may be required.
- Both loan options offer lower interest rates than other loan types.
- Cons:
- Since you are borrowing, you have to pay interest.
- It’s true that the 401k interest is paid to yourself, but keep in mind that you are losing out on the earning power of the money if it was left invested.
- Additionally, you have to pay back the loan with after tax dollars… and you will likely be taxed again when you ultimately withdraw the money in retirement. Double taxation, yikes!
- If you leave your employer before the loan is paid back you may be required to pay back the loan within 60 days and if you don’t, that remaining amount is considered an early withdrawal with all of the corresponding penalties.
- If you rent your house, or if you have low equity in your home, then you may not be able to obtain the amount you need.
- If you default on the HELOC you could… well… lose your home in to foreclosure. Double yikes!!
Selling Our Rental House
One rather unique option we have available is that we have a rental house, which is our former primary residence. We could try to sell it and use the proceeds to help provide the needed money. Our decision to rent the house was primarily based on a desire not to lose money on it due to purchasing the house at the top of the market (2008) in an area where the housing market still hasn’t recovered fully from the recession.
This situation was not improved when the neighboring city received quite a bit of negative publicity on a worldwide scale a few years back following a period of civil unrest… it rhymes with Shmerugson.
While we receive decent rent, there are large maintenance needs in the near future which could wipe out any cash flow we’ve received thus far. However, there are signs that property values are finally creeping back upwards. Maybe the time has come?
- Pros:
- We could make a chunk of money on the sale of the house which would go a long way towards covering the costs anticipated.
- We would no longer need to worry about tenant issues and property upkeep.
- Cons:
- The current lease expires during a traditionally slower part of the year for real estate.
- We would lose out on the passive income and tax benefits of having the rental.
- We will need to spend a potentially significant amount on repairs and updates to get the house market ready.
- We’ve tried selling it twice before with no takers, so there is no guarantee we can sell it in the time needed.
Path Forward
As you can see, we have several options to weigh here. So how are we sorting through them?
- Since the time frame is so short (best guess within 2 years), we want an option with low risk. As much as I like to think I can handle a bit of gambling, I don’t want to have to take out a loan because of some inopportune market craziness. Additionally, in looking at the price to earning ratio (PE ratio) of the S&P 500, it seems like equities are quite pricey. This suggests lower returns are in store at some point. My guess is sooner than later. That guess is worth about how much you paid for reading this (jack squat). So we will probably avoid equities for now.
- Additionally, since the time frame is uncertain, we want to make sure the money is accessible with short notice. Liquidity is key. This rules out CDs with longer maturities.
- This is underscored by the fact that we are still rebuilding our emergency fund following last year’s student loan payoff and my recent car purchase.
- We have been using a cash back credit card that is tied to our checking and savings accounts. Once we reach a certain savings threshold a rewards program kicks in which offers a decent increase in the cash back percentage.
All told, right now we are planning to stockpile the money in our money market savings account. We will need to evaluate whether there are more lucrative options available, perhaps through an online bank or credit union. So that will be our savings vehicle. But what’s driving this saving’s bus?
The reason this goal is even remotely attainable is that we have spent the last couple years attacking debt. We knocked out student loans last year and we paid off my silly car this year. We are also very fortunate to have good jobs that pay well. We plan to continue to use our Cash Flow Budget Process to maximize our monthly savings contributions. We are hoping to stash away $1,000-$2,000 a month to meet this goal.
What if the Opportunity Doesn’t Pan Out?
This is certainly possible. It may not be offered or it may turn out to not be a lucrative investment. I could also burn out at my job and quit before it’s offered. I’m half joking here.
In any event, I would undoubtedly be bummed out a bit. One for the offer to not pan out and two, for the loss of potential earnings from keeping our money out of the stock market and locked up with a lower possible return. But there is a silver lining in this scenario. We may end up with enough cash on hand to explore other investment opportunities. My wife and I are addicted to real estate. Perhaps having some unencumbered cash will allow us to dip our toes back into this market. Perhaps the house of a lifetime becomes available at a great price. Perhaps we find a great flipping opportunity, or even a second rental.
Either way, I am excited that this is even a possibility. No matter where this goes, if we can stick to our savings plan, we will find ourselves in a much stronger financial position one way or another.
Thanks for reading.
5am Joel says
What an awesome breakdown of your short term options. My wife and I discuss this topic constantly.
I too am obsessed with real estate and like to have access to large amounts of liquid cash. I feel bad sometimes, for months on end, having tens of thousands of dollars sitting in a checking account not actively ‘working for me’. But when that sweet day comes and I jump on a new opportunity, I am always thankful I kept such a large amount liquid. I just exited my first out-of-state flip and made a very healthy return. It wouldn’t have been possible if I couldn’t access a large sum of cash within 48-72 hours. 🙂
Looking forward to hearing more as your new work opportunity unfolds!
Mr. Heartland on FIRE says
Thanks Joel! And congrats on the success with the flip! That’s very exciting.
We’ve kicked about renting and flipping for years and it usually came down to not having a deep pool of cash to draw from on short notice, just as you said.