A HENRY's Guide to Saving for a Large Down Payment
Where to invest your savings for a major purchase
As a HENRY (High Earner, Not Rich Yet), I've been grappling with a financial conundrum that many of us face: how to save for a large down payment on a home. My spouse and I are in our 30s, living in a very high cost of living area, and we're looking to purchase a larger home in the next year or two. The price range we're considering is between $2.5MM to $3MM, which means a down payment of $750k - $900k if we assume a 30% down payment.
The question that's been keeping us up at night is: where should we hold these funds? Should we keep investing earned income into the market? Hold it in cash? Or are there other strategies we should consider?
High Yield Savings Accounts & CDs
After discussing this with my friends, I've received a variety of responses. Some suggested holding the funds in a high-yield savings account. As of May 2023, here are some of the more attractive rates out there:
Marcus by Goldman Sachs: 4.15% APY with a $0 minimum opening deposit.
American Express National Bank: 3.90% APY with a $0 minimum opening deposit.
Others friends suggested laddering bonds or CDs, although the yield wouldn't be much higher. Marcus is offering a 10 month CD with an APY of 5.05%, and a minimum deposit of $500. CIBC Bank is offering 5.27% on a 1 year term with $1000 minimum deposit. But then you lock your funds up for a year and there are early withdrawal penalties.
How safe are your Savings in a Bank?
An important consideration that came up during our discussions was the safety of our savings. Is it smart to hold all of your money in one place, especially with community banks failing? The answer is that diversification is key, even when it comes to where you hold your cash. Spreading your savings across different banks can mitigate the risk of a single bank failing.
Another crucial point is the role of the Federal Deposit Insurance Corporation (FDIC). The FDIC insures deposits up to $250,000 per depositor, per FDIC-insured bank, per ownership category. This means that if your bank were to fail, the FDIC would cover your deposits up to the insured limit.
Box Spreads
One friend suggested a more unconventional approach: laddering box spreads, three months out. This strategy offers about 1.5% interest, and if you go out 6 months or more, it's over 2%. This is near risk-free if you hold to the expiration, but there's interest rate risk if you need to exit early.
A box spread is an options strategy that involves the simultaneous buying and selling of a bull call spread along with a bear put spread, with both vertical spreads having the same strike prices and expiration dates. The box spread is essentially a combination of two opposite positions, a long call/short put and a short call/long put, that has the effect of creating a risk-free position.
"Laddering" a box spread involves setting up multiple box spreads with different expiration dates. This is similar to a bond ladder, where bonds with different maturity dates are purchased to balance risk and return.
However, it's important to note that while a box spread can theoretically be a risk-free position, in practice there can be risks associated with execution, including the ability to buy and sell the options at the desired prices, and the risk of early assignment on any of the options. Therefore, while it can be a useful strategy in certain situations, it's not without its potential pitfalls and should be used with caution.
Cash is King
However, the consensus among my friends was that cash is king in this scenario. With our income level, it shouldn't take more than a few years or so to save a down payment from scratch. So market gains are likely not to move the needle much anyway.
Whats our plan?
After much deliberation, we decided to go with a 50/50 approach. We're saving $300k in cash and leaving the other $300k in the market. This decision was made easier after speaking with our mortgage broker, who informed us that there were options for a loan up to $3MM at 20% down.
In conclusion, the best strategy for saving for a large down payment as a HENRY depends on your individual circumstances, risk tolerance, and timeline. For us, a balanced approach of saving cash and investing in the market was the best fit. But remember, there's no one-size-fits-all solution. Always do your research, consult with professionals, and consider your own comfort level with risk. And don't forget, diversification and FDIC insurance are your friends when it comes to safeguarding your savings.