It’s a common question from folks saving up to buy their first (or next) rental property, house-hack, or primary residence:
Should I keep my money safe in a checking account?
Or, should I somehow invest this money so that I can earn a return in the meantime?
This blog post will give you the tools you need to make the right decision for you.
And let me start off by saying that I’ve been there. I’ve been the guy who’s hungry to get started. The guy who is hustling and grinding, month in and month out, to save at first $1,000, then $1,200, then $1,500 per month. You rack up your first $4,000, then your first $7,000, then $10,000. And still, after months (or years) of saving, it’s not quite enough to comfortably purchase an investment property or a home in your area.
It’s slow, it’s painful, and it’s infuriating.
You’re anxious to get started investing, making your money work for you, and ready to begin accelerating towards financial freedom.
I get it.
The answer can’t be to just sit tight and stockpile cash — tens of thousands of dollars in cash — in a bank account while preparing to buy that first (or next) property, can it?
The correct way to stash cash while saving for a down payment is different for everyone and depends upon circumstance, the length of time for which you intend to invest, and your tolerance for risk and reward.
But, I will preface this post by saying that very few people invest their way to a meaningful down payment. The fact of the matter is, this discussion really only exists for someone who is capable of saving systematically toward the next down payment. If you are unable (or unwilling) to save, and have only a small amount of cash to begin with, this discussion will be largely meaningless to you. If you’re unable or unwilling to steadily and aggressively accumulate wealth, you need to find a way to create enough value to purchase a property, or find a great deal and finance with other people’s money.
That said, let’s talk about the differing philosophies behind how to approach saving for the next down payment. We’ll dive into why certain options may be better than others for different folks, and then I’ll explain my personal approach to saving. Then it will be up to you, of course, to decide what to do with your cash.
The three Philosophies for storing cash while saving up for a down payment are as follows:
1. Keep the cash as safe, accessible, and insured as practical
Keeping cash accessible, safe, and insured against loss almost always means storing it in the bank. In today’s world, it’s probably safer to keep money in the bank than to keep it anywhere else. It’s insured by the Federal Reserve. It’s accessible instantly via wire transfer, debit card, or a bank visit. And you aren’t going to lose big on an investment that goes south if your money is parked safely in the bank.
Pros: flexibility and the ability to multipurpose the money
As I grow my real estate business, my expenses and potential need for cash continuously grow. I have separate bank accounts for each of my properties, and I keep a large reserve in them to protect myself from the inevitable months in which I have to spend tens of thousands of dollars fixing a roof, replacing a bathroom, turning over a unit, etc. — or potentially doing all of that at once.
I’m much less likely to incur these types of large expenses in my personal life than in my business, so I keep an additional, smaller reserve, for personal needs.
At first, when I was building up my savings, all the money was jumbled together. I didn’t have any property, and so why would I set aside money for a down payment? I just built up ALL my cash in the same bank account. This cash wasn’t necessarily just for a down payment on my first property, it was also my emergency reserve — my financial runway. It gave me options, not just for a down payment, but also the ability to survive (at first months, then years) without needing a traditional job.
This flexibility, and simply having a large cash reserve, brings an incredible peace of mind. Perhaps even more importantly, it exposes you to opportunities. Meaning, if you are looking for them, you might be able to spot investment opportunities to exploit thanks to your favorable cash stockpile. These deals won’t be available to investors without ready funds.
Cons: 0% interest on your savings at most
Your money is losing value to inflation with every passing month. If you do not deploy it, you are almost surely losing slowly. This disadvantage compounds as your stockpile grows. Earning a 0% return on the first $3,000, $5,000, or $10,000 is very different from earning a 0% return on $100,000, $250,000, or $1,000,000.
2. Seek a modest — but relatively safe — rate of return
Pros: earning rather than losing
This is a popular philosophy among investors who are careful planners but have a pretty rigid budget. If you can accurately plan out when you will need the money, and are willing to forgo some flexibility in terms of how readily accessible your funds are, you may be able to eke out 1%–4% returns on your cash. CDs, money market accounts, treasury bonds, and the like, all offer very modest returns that are unlikely to drop in a way that will materially impact your goals. Proponents of this approach will argue that “earning something is better than nothing,” and they are absolutely correct.
Cons: limited returns
The disadvantage to this approach is mediocracy of your returns. You’ll ensure that you earn modest returns in the months and years leading up to your first purchase, but those earnings will amount to an extremely small amount of money. If you are saving up for your first down payment, and need $50,000 to do so, with a conservative approach you’ll earn (at best) around $500–$2,000 per year. This money is not going to make a big difference in your day, but, again, it’s certainly better than nothing.
3. Seek The Greatest Semi-Liquid Return Available
It’s no secret that many of the greatest returns can be generated from illiquid investments — investments that you can’t easily sell. (Think real estate, small businesses, startups, websites, etc.) While it’s possible to sell some of these assets quickly, often doing so in haste results in losses for the seller. That’s why it probably, in most cases, makes sense to invest in assets that can be sold within hours or days. Think about a money market account. Within hours, funds can be transferred out of a money market account and into a bank account.
Pros: high Returns
In all likelihood, for the majority of folks, the highest potential returns from semi-liquid investments will come from publicly traded securities like stocks, funds, ETFs, and REITs. Publicly traded securities can be sold during regular hours on most business days, and the proceeds can be transferred to your bank account. You’ll be ready to buy real estate in about a week.
So, it is very realistic to simply take your cash and invest it in the stock market, or other publicly traded securities, and then sell off those assets when you are ready to buy real estate.
The advantage to this is that you expose your money to asset classes that historically produce much higher returns than checking or savings accounts. The data set from NYU’s Stern School of Business shows a total compounded return of just under 10% over the long run from an investment in the S&P 500, for example.
Cons: higher risk
The disadvantage is that public markets are much more volatile than more conservative investments like the savings and checking accounts mentioned above. This means that there is a very good chance that employing this strategy in the long run will result in a very bad year at some point. It means that a significant percentage of your savings may get wiped out, potentially delaying your plans to invest in real estate. You will lose if you employ this strategy over the long run — most likely multiple times.
My Strategy of Choice
I employ option number 3. I keep cash reserves in the bank for my personal expenses and for my real estate business. But for the past four to five years, I’ve invested all the money for my next real estate project in the stock market, almost entirely in index funds. I absolutely understand the risks and downsides that come with keeping my money in the market. I am aware that the market may come crashing down some day. In fact, I’ve been told that for years.
However, I trust my system, and I trust history. Even though I know I will lose occasionally over the next years or decades, I trust that over time, I will achieve close to the stock market’s historical return (8%–10%) on my invested assets. I trust that my gains will significantly outweigh my losses.
This is my choice. So far I have benefitted greatly from this approach. The past few years have been friendly to investors with holdings in the market. I am fully aware that at some point I will face consequences from my approach, perhaps shortly. But, as I am not smart enough to time the market, I will trust my system. Maybe I’ll have another great year and be able to buy more real estate than planned. Maybe the market will collapse and I’ll be set back months or even a year. But, over time, I believe that the math will be on my side.
What’s the right approach for you? Perhaps you think that my approach is foolish or dangerous. Perhaps you find it has merit. I don’t know what the right answer is for sure. But, I wanted to share my theory with the community to generate a discussion and feedback.
There is no one right way. My circumstances may be very different from yours. I have already established several properties and a large emergency fund. I have great insurance and healthcare through my employer. If I suffered a surprise bankruptcy, I suspect that my parents would let me move back into their basement while I straightened things out. These safety nets enable me to take more risks and be more aggressive than the folks with families who want more flexibility and value conservative investing in case they need to bail out the family from an emergency.