Dallas, TX · Member since 2017 · 52 posts · 5 votes
I am currently saving for my first down payment on a buy and hold real estate property. I'm using Barclays with their really high 1.5% APY savings account. A lot of people will argue that if you are saving for a down payment you shouldn't put your money in something risky like the stock market. But if you are saving for an investment property, why not double down and invest my savings for a down payment in the stock market to potentially capitalize on higher gains and try and make my money work harder for me until I pull it out and invest it in real estate? Arguments for or against this idea?
If real estate is your focus and goal, don't invest in the stock market. Whatever you focus on, grows. A short term correction can wipe out any potential gain. I would only invest what I was able to lose, especially if I want to repurpose into real estate.
If you are interested in going the safe route, there are some banks that give 4%+ interest on savings accounts. There are some with no early withdrawal penalties, but it takes some work. See the link below for all your options.
I put a portion of my saving for a property into a mutual fund product provided by a company called Betterment. Very easy to set up, I did this in 2014. A year and a half in, and I was down 2.5k, roughly 1/6th the total balance. Having just waited it out I am now up 4K. The volatility doesn’t work well in the shorter term, I would be hesitant to recommend this to someone looking for property in the next 1-3 years. Just my 2¢
It's impossible to time the market and can't predict the future. There are so many different forces at play that could impact the stock market and/or the real estate market. I have missed out on some gains by choosing to hold my cash liquid (not all of it though) instead of investing it somewhere. My rationale for this is that I am more comfortable with having a guaranteed amount rather than a portion of that loss because I want to be ready at any point to pull the trigger on a potential real estate deal. In the event of any market correction or decline, that significantly reduces my ability to quickly move on deals. The reverse is also true as well so in the end it just matters how much risk you're willing to take and what you're comfortable with
So while saving up for your next investment property, why not have a hybrid, keep half of your money in a high yield savings and half in a higher risk field? Invest some, save some?
Or, one more way to look at it. What if I'm a person who invests in the stock market. Would you suggest taking my money out of stocks to then invest in real estate?
@James Krahula A hybrid theory exposes you to the same risks.
When you say you want to invest in the Stock market, what exactly do you mean? Individual securities, indexes of equity markets, bonds, Futures, swaps, commodities,currency, Mutual Funds or ETF's of stocks or bonds? This will help neck down the discussion.
Then it comes down to what want to be good at. Do you want to invest in equities? Cool go do that. Do you want to invest in RE? Nice, focus on that. In each investment class you have to remember that their are winners and losers. Everyone is out trying to find an edge and they have no qualms about taking advantage of someone who is under prepared to be trading in that market.
@Account Closed so then you aren't saying much of anything? Any cash in a checking account is earning interest, which, by definition, is working for OP. Rate of Return, risk, liquidity. None of those matter?
@James Krahula Check out this chart. If you bought in Nov 15 and then sold Feb 16. You would have suffered loses of around 7%. Of course you could have bought Feb of 16, sold in March and made a profit. However, at that point you aren't investing, you're speculating.
Alright, I did the math, please let me know if you see any mistakes. I grabbed the historic monthly returns for the S&P 500 from 1990 and ran them against a savings account of 2% and a savings account of 5%. In this scenario we will also be investing $1000 each month. You will see links to all sheets at the bottom. Here are the scenarios for each sheet.
Control: We will invest $1000 each month and calculate the monthly returns.
House: The Control Sheet plus every time we reach $25,000 we will take that money out and purchase a house.
House+CF: The House Sheet plus we will include cash flow by adding $100 to our monthly investment for each house we buy.
2007House+CF: The House+CF Sheet but we started investing in 2007 so the Great Recession hits before we can purchase our first home.
Green helps identify when a house purchase was made, and at the bottom you can see how many houses were purchased.
So please, double check my math, point out any flaws you can find, and let me know what you think after looking at the numbers!
@James Krahula The risks associated with putting one's DP capital in the stock markets while you are looking for the next deal are too many to list. Remember, putting money into the stock isn't always doubling down, as one could lose all that money in an instant.
Also, I think there should not be a difference in where you hold the DP capital for a personal property and for an investment property.
I like the model you put together, especially accounting for cash inflows and outflows through your investing career: good stuff. I don’t know if you ever heard the quote “All models are wrong, but some are useful” I always keep that in the back of my head when doing stuff like this. I can’t see anything wrong with your execution, but your underlying premise have some issues. First off, you don’t drive a car by looking through the rear view mirror, so modeling future returns off past data introduces a host of flaws. The US economy has a much different make up, the geo politics are different, technology plays a far different role in the markets, the laws governing companies have changed from 1990 and even 2007 to now. Your model, while correct, has a limited use today. Can you fix these issues? Sure. If you want to, look up a Monte Carlo methods, which at a 30,000 foot view, use historical data and the Law of Large Numbers to create a general range of expected results. An output looks like this. I think you’ll find this method is overkill for the question you’re asking. You can eliminate choices in a much simpler way.
Your data showed that you can’t buy significantly less homes by investing in a savings account than the S&P in either your 2007 or 1990 model. (I’ll ignore the House+CF since we are talking about what to do with your capital and House+ CF adds more variables to the situation) So the question is: what makes savings different than the S&P. The answer is risk through volatility. I can’t manipulate your data, but if we make an incredibly simple (and yes dangerous, just ask the guys at Long Term Capital Management) equivalency between risk, volatility, and standard deviation, you’ll see the difference. The mean return for 1929-2015 was 11.4% with a Standard Dev 19.7%. This means that 68% of the time the S&P’s YoY return was between -8.3% and 31.1%. The standard dev of the savings account: 0%.
Are there ways to account for this risk? Yes, but I’ll argue that you want to invest in RE and not equities, so why take time learning about risk mitigation in equities when you could spend that time reading about your interests, real estate. You are working hard saving money only to put those funds in jeopardy by investing in a risky asset. I get optimizing, but chasing what in the long term amount to marginally increased returns doesn’t make a lot of sense to me, especially when the down side is capital loss and the potential of delaying your purchases, which impacts the main wealth generators of RE, cash flow, amortization, appreciation, and tax savings.
@Account Closed We are giving the same advice, since his funds are in a high yield savings account earning 1.5%, which is within 15 basis points of most Money Market accounts. I commented thinking you were a fellow value investor who understood the teachings of Ben Graham, but I was wrong. My bad. You have a different strategy. That’s cool. Though there is no need to use ad hominem insinuations when trying to get your point across. BP is about helping each other and sharing ideas, not proving who the smartest guy in the room is.
@James Krahula in order to refine your math a little bit you should incorporate fees into the stock market investment assumptions. Both trading costs (for every monthly buy order, and for each sell order) plus reduce all your returns by management fees. Maybe find a low cost SP 500 fund and use M/M returns from that instead of the broad market which a retail investor can't gain access to.
Also, in order to really get a better sense of comparing strategies, you would have to do it after tax. You would be incurring a fair amount of cap gains tax over the life of the the stock market strategy by trading in and out so much. The HY accounts interest income would be taxed at ordinary income (a CPA can fact check me on that), which is a higher rate but you would have less in absolute gains to get taxed on.
In general, your 2007 sheet highlights the main argument for using a fixed income instrument or HY savings account over investing in an ETF/Index Fund to save. Volatility. Is acquiring 1 extra property worth sitting on the sidelines for an extra 8 months? It depends on your goals, what returns you'd be getting on your property, and many other factors.
Timing and frequency also make a huge difference. Your sheet assumes that this is a long term rinse and repeat strategy which benefits more from long run averages. Playing around with various months in start date and time horizons can paint very different pictures.
Awesome insights, this has been very very cool. The goal is long term investing, I'm not looking at this strategy for the next 5 years, I'm looking at this for the next 30 years. Long term, does this strategy play out, or because you and taking money out every few months does this increase risk, or does it lessen risk. I don't think there is a right answer to this, but I don't think it is as bad of a strategy after looking at the numbers as our gut tells us.
It really all depends on your risk tolerance. I can't make any individual recommendations without sitting down to review goals, financial situation, and putting a ton of time into analyzing the strategy (CFA ethics violation otherwise).
Personally I would never invest acquisition funds in anything other than cash equivalents, or a AAA FI instrument that provides cash flows that match my desired draws. Laddered investments could work, doesn't all have to be short. But I am conservative and I want to know that my funds will be there when I need them. I don't want stock market returns to drive my acquisition schedule. Also to quote Buffet again in this thread, when it comes to broad market passive investment, "my favorite holding period is forever." Most of these reasons are behavioral though, and betraying my quant background.
With all that being said it's really awesome that you tested the numbers to challenge conventional wisdom! I'd refine your returns a little bit as they are overstated, test out what starting at different horizons look like, and take a sober look at whether you can stomach it. I can help you fix the formulas to automate the $25k draws so you don't need to recompute them every time you change the date.
@Alex V. yeah if we can make this more accurate I'm all for whatever alterations need to be made, and I always want to calculate on the conservative side.
@James Krahula this has been a fun discussion, thanks for making it happen.
Refining your model is great exercise to learn, but at the end of the day you'll just end up with a precisely inaccurate model.
I'd argue that even if you do this for 50 years it isn't long term investing. It is a series of short term investment made back to back since you liquidate most of your capital every few years. Delaying transactions costs, postponing capital gains, and avoiding timing the market are all hallmarks of long term investing and your strategy has none of those.