Monday, April 23, 2007

How Should I Invest My Down Payment?

I have had numerous questions about how one should invest a down payment if one is waiting for the real estate market to go through a correction or if one just needs to save more money before making a purchase.

I have a few thoughts about the subject and the answer largely depends on a person's risk tolerance and time horizon, as with all investments. Here are a couple of scenarios for us to consider:

1) For less than one year until purchase and/or low risk tolerance, this person should not have any equities in the portfolio to be used for the down payment. A money market mutual fund, cashable GIC, high-interest savings account, or short term bond fund would all be suitable selections. The major considerations I would have in this situation are first, liquidity, and second, the highest rate possible over such a short time horizon. Some good money market funds are the TD or RBC Premium Money Market and National Bank Corporate Cash Management funds.

2) For more than one year but less than five years and/or medium risk tolerance, this person should have 20% to 40% of the portfolio in large-cap and dividend paying equities plus a combination of GICs, bonds, and/or bond mutual funds. Some great 'all-in-one' passive solutions would be the TD Income Advantage Portfolio at the more conservative end, or the CI Portfolio Series Income Fund at the more aggressive end. Alternatively, you could buy a cashable GIC or money market fund with 60% to 80% of the money and buy 1 or 2 of the top ten Large Cap Dividend mutual funds in Canada with the rest and for some spice you could add a Global Dividend fund. Most of these funds offer low volatility and great track records.

3) For longer time horizons or for higher risk tolerance, this person could have up to 80% equity depending on the risk tolerance level and the investment opportunities available are very wide and I would just direct you to stay conservative with a focus on Large Cap Dividend investments.

In general, avoiding income taxes on the portfolio should be pursued, and a focus on dividends and capital growth is very advantageous. Some mutual fund companies offer funds that shelter interest income from the full rate of taxation and these funds are widely available through any investment dealer. They are sometimes referred to by a series letter or as a corporate class fund.


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casual observer said...

I would be quite cautious with money to be used for a down payment. If housing prices go down anywhere near what some people are suggesting, the economy will take a hit.

If the economy takes a hit, the stock market may not be where you want to have your money invested, even if the time period is five years.

I remember looking at five year returns on equity mutual funds a couple of years ago. Some of these were near zero or even slightly negative. People would have been better off just leaving their money in a high interest account, with a lot less risk.

BTW, The TD and RBC Premium Money Market Funds, and The National Bank Cash Fund that are mentioned in the thread all have a $100,000 minimum initial investment threshold.

If you're looking for a good money market mutual fund (***** - Morningstar Rating) with a low initial investment threshold, the best I could find was the Altamira T-Bill fund. The minimum initial amount was only $1000.

As an alternative, ING Direct pays 3.5%. Presidents Choice pays 4%. Neither of these require you to lock your money in for any length of time, and neither has any service charges.

Warren said...

I agree with casual observer, regarding the possible connection between housing and the equities market.

But assuming one is willing to invest in the market, would you recommend US or Canadian.. or other? Specifically I'm wondering about the value of the C$. There are excellent tax benefits to a Canadian company for dividends which can't be ignored.

For high savings, ETrade offers a 4.15% account, no fees. I don't know if you need to have equities with them, but I don't think so.

freako said...

"Specifically I'm wondering about the value of the C$. "

Oil/resource prices down, C$ down. That could be a double whammy if you are invested in Canadian energy stocks. That is if oil/resource prices cool. They may or may not, but if U.S. goes into recession and China's growth slows, they likely will.

I'd stick with cash, or possibly a long short hedge.

freako said...
This comment has been removed by the author.
beta said...

But assuming one is willing to invest in the market, would you recommend US or Canadian.. or other? Specifically I'm wondering about the value of the C$.

That's the $64k question. At this point, things could go either way...but I'm more pessimistic about the US$.

My wife and I had money in a US$ account which we exchanged a while ago into C$. Time will tell if that was a good move or not.

We're currently out of the market and have our savings in GIC's and PC bank at 4%. It barely keeps up with inflation (arguably doesn't), but I don't trust the market right now.

A couple of people who I respect are strictly day-traders now, as they don't want to keep money in the market overnight.

beta said...

Bloomberg: Subprime Bondholders May Lose $75 Billion in U.S. Housing Slump

More pain to come.

patriotz said...

would you recommend US or Canadian.. or other?

Which country has to borrow $2billion+ from the rest of the world every day? Want to lend part of that?

What happens if the other lenders get cold feet?

blueskies said...

2 questions:

if the Americans head into a recession with inflation still a threat how would that affect Canada?

what investment would you look for to take advantage of rising interest rates?

mohican said...

Regarding US vs CDN dollar investments, for a down payment I would be wary of investing too much outside the country because of currency fluctuations.

Assuming a tolerance for some risk and a decent time horizon, investing a portion of a down payment in dividend equities is not all that risky. In previous market downturns, large cap, dividend paying companies do quite well. Look at the annual return data for some of the best Dividend funds - TD Dividend Growth or AGF Large Cap Dividend. Volatility is quite low but the upside potential is fantastic.

rentah said...

2 cents worth:

Currently USD is at very long term supports (80 on the dollar index).
Also, everybody and their dog is betting that the USD is now a one-way bet down.
Thus, using contrarian principles, watch the USD make a nice bounce here, perhaps with a target as high as 90 on the dollar index.
This will likely co-incide with weakening loonie when cf USD, but less so than for other currencies 'cos we're joined at the hip with the US.

FTR, I believe that the USD is eventually going to breakdown, but that's a very low frequency event, and it'll likely happen when nobody expects it.

rentah said...

While we're talking about investing, we may want to add a word for those who want to gamble with all or part of their future downpayment. This'd be for those with high risk tolerance or those with small pots and lots of youth.
Also, it's a position for those folks anticipating US recession:
Long USD (next 6 months).
Long US treasuries (eg TLT).
Short QQQQ (or long position in instruments like QID).
and higher risk but same theme:
Short Emerging markets(eg short EEM).
Call me krazy, but keep an eye on this prediction too.

freako said...

"In previous market downturns, large cap, dividend paying companies do quite well."

It very much depends. High dividends generally fall in two categories:

1. A company in big trouble that has yet to cut dividends.

2. A utility/bank

The first category will certainly be bad news in a recession, unless they happen to dabble in contrarian products.

The second category needs to be looked at in detail. If the utility is a pipeline, that could be bad news, as could natural resource extractors. What about banks? It really depends on their mortgage exposure.

patriotz said...

if the Americans head into a recession with inflation still a threat how would that affect Canada?

US inflation is not really a factor, what matters is real demand, and that's going to go down whether there's an inflationary or deflationary recession.

IMHO a US recession is in the bag, and it could be inflationary if the Fed tries to fight it with more easy money. Give the alcoholic another drink.

As for where to put your down payment, long bonds or preferreds have the same correlation to interest rate moves as RE, and long bonds almost always do well in a recession, barring inflation. And I do have faith in the BoC fighting inflation, it does not have any motive to sink the currency unlike its counterpart south of the border.

I also have some floating rate preferreds which are a hedge against interest rate increases. All preferreds yield dividend income which has a great tax advantage in BC.