Recently I decided I’d like to purchase a house within the next couple of years. All my life I had been renting and I was ready to take the next step towards home ownership. I began focusing on saving for a down payment on a house rather than just grouping all savings together. I quickly realized though that I’d have to differentiate the money that was earmarked for a house versus just a general savings account. This led me to the question of “how should a person invest money that is for a down payment on a house?”
I could keep the money in a high yield savings account, unfortunately right now I'll get next to nothing in interest for my hard-earned cash. When holding money for a down payment, however, this is one of the smartest things a person can do even though they won’t earn much. In today’s low interest rate environment, they're looking at about 1% annually on their balance. This means that if a person is holding $10,000 in this type of account they’d earn $100 in a year, not too much in the grand scheme of things. The main benefit of doing this is that they're basically guaranteed to earn that 1% and will never lose money. If inflation picks up, however, they could lose purchasing power.
An alternative to this low-risk, low-return approach would be to tempt fate and put the money into equity markets. As many of you know the stock markets are a fantastic long-term investment plan, unfortunately for short-term goals this is one of the last places a person should keep money. It's easy to see why people would behave risky with their down payment money since lenders are putting more and more pressure on borrowers for a large down payment. Even so, risk should be avoided at all costs. A terrible situation would present itself should someone place their life savings into the markets knowing that they need access to it within a year or two and then suffer a 20% loss. Because of this I do not recommend that anyone invest in the stock markets money that they're planning on using for a house/car within the next 24 months.
This scenario above made me realize that I wanted equity market type returns with a near risk-free investment. In other words, I wanted to invest in something like a 12-month certificate of deposit, but instead of earning 1% interest I wanted to earn near 10%. The truth though is that this simply doesn’t exist in today’s economy. If this existed everybody would already be doing it, which in turn would make it not exist for long. For short periods of time, however, I think I may have found the solution. I figured I could make 10 to 15% returns annually for 1-2 years with virtually no risk! As time progresses and my down payment balance increases my annual return percentage will decrease some, which is why 10% forever with this plan is impossible. But because the timeframe is short-term this plan is the perfect solution to achieving above average returns while maintaining a risk averse strategy.
So, what is the strategy to obtain above average returns with a below average risk level? The solution that I decided to use was to “invest” in new checking/savings accounts for 3 to 6 months at a time. By opening multiple accounts and spreading my existing balance around I could gain access to bonuses that large banks offer new customers while keeping it free of fees. Because competition is so high right now for new customers banks seem to consistently offer these perks. By creating a list of these offers and analyzing the time needed to reap the benefits I determined that I should be able to earn about $2,000 a year using this strategy. This amount is excluding any actual interest that these banks may offer as well as still maintaining a relatively large balance in a high yielding savings account. This investment strategy takes a little bit of elbow grease in terms of maintenance, but it’s one that should payoff well. I estimate the time spent per account to be roughly one hour. As the bonus payouts range from $150 to $400, however, this simply means that my average hourly rate for work is anywhere from $150 to $400 as well. Since I’m not a professional athlete or neurosurgeon whose pay is already this high, I will gladly work a few extra hours to get the income boost. Look at the chart below to see hypothetical returns on a pre-determined balance using this strategy.
The above returns are calculated assuming a total of 12 checking/savings bonuses are recognized in a 12-month period with an average bonus of $175, $3,000 of the initial balance is spread out between accounts, and the remainder of the balance is invested in a high-yield savings account earning 1% interest annually. On the surface 12 different accounts may seem like a high amount, the truth though is that plenty of banks are offering these bonuses, many offer both a checking and a savings bonus, and some even offer bonuses that are much larger than $175. The beauty about the strategy is that I didn't even have to go into the banks to sign up for the accounts. Unlike 15 or 20 years ago when online banking was relatively new and still untrusted, in today’s day and age I can just sign up from the comfort of my own couch. Just last week I received a $200 bonus deposited directly into a newly created account and in two weeks I should receive a total of $450 from two separate financial institutions.
In a future post I’ll detail specific bank accounts that can help people achieve this above average return. For now, however, I’ll just say that a couple of google searches should point someone to a dozen or so banks that offer these bonuses. You may be wondering why I consider this investing since it doesn't require money to start doing it. The reason is that some bonuses require a minimum balance in the account. For example, one bank offers a bonus of $400 if someone maintains a minimum balance of $10,000 for several months. Although this example is a high minimum balance amount, you can see that to achieve the higher bonuses a person will need some capital. There are some things to keep in mind as well should a person take this approach on their own. Below are several pros and cons to always keep in mind.
Low Cost – Account openings are typically free with the deposit of a small amount. If criteria are met most accounts are free to maintain. Certain accounts may charge a monthly fee of about $10. Since no money is invested in the stock market, however, there are no commission or trading fees.
High Rewards – As can be seen from the chart above a person should be able to generate at least a 5% return on their money. The lower the initial balance the higher the return percentage they will make.
Give banks a trial run before choosing just one – I’ve found certain banks that I really enjoy working with by doing this. From their customer interface online, to dealing with customer service, I’ve found that not all banks are created equal. When the dust settles and I’m ready to maintain just one relationship with a bank I’ll have a much clearer idea of what I am looking for.
Accessible Cash – Because a person's cash will be in various checking and savings accounts they’ll have access to the funds if needed. Since they aren’t tying money up in CD’s or various lending programs, they will be able to access the cash should they find their dream home earlier than planned.
Protection from market downturns – Since people aren’t investing in equity markets they don’t have to worry about any bear markets (in fact they may even be hoping for one secretly so that house prices fall).
Never far from a branch – Hate the feeling of being miles away from the bank? When using this strategy, it’s nice to know that there will always be a bank close to have an account with.
Time consuming – As mentioned earlier it can take roughly an hour to find a bank to use and open an account online. Additionally, you must determine what criteria you must meet to generate the bonus and then strategize on how much money to leave in an account.
Expenses may be incurred – Most expenses can be voided by either keeping a minimum balance in the account or having direct deposits. Even so, it is possible that some accounts will charge a monthly fee. It’s always best to read customer agreements before opening the accounts to see what a person can do to limit any charges.
Multiple accounts to track – This really isn’t too difficult anymore with the advent of apps such as Mint, but it still may be frustrating for some. I am used to only having one debit card and one credit card in my wallet but with each new account comes a new card to keep track of. I’ll just leave any that I’m not currently using somewhere secure at home so it makes life easier.
Multiple direct deposits at a time may be needed - Many of the checking account bonuses require a direct deposit (or several) be made into the new account. If trying to achieve the highest return possible make sure to check with your employer and verify that you can split your paycheck into multiple direct deposits.
Additional paperwork – Similar to receiving multiple cards, you’ll now have multiple statements. Since most are received online this burden isn’t as bad as it seems. One thing to keep in mind though is that come tax time you’ll receive multiple 1099s since the bonus payouts are considered interest.
Friends will look at you funny – You may here the questions “are you serious?”, or “Really?” more often than you’d think. I’m okay telling people about this plan though, all I have to do is show my rate of return.
One argument against this method will be that when purchasing a home, mortgage bankers don’t want to see money constantly moving between accounts. That's because this gives the lender the impression that a person may not have the amounts they say they do. The best thing to do is to stop using this approach about 60 days before making an offer. Just consolidate accounts into one so it’s easier to show the lender proof of funds.
Does this approach seem like one that you could see yourself doing or does it seem like more hassle than what it’s worth?