Thursday, August 07, 2008

Down Payment Dillemna

In response to several of the comments on the previous thread I'm posting some thoughts on what to do with your downpayment if you are patiently waiting for housing prices to have some kind of resemblance to fundamental valuation before you purchase. Here are the essential steps in my humble opinion:

Step 1: Determine your time horizon - this is easier said than done.
Step 2: Determine your risk tolerance - is some level of value fluctuation acceptable and if so, how much? +/-5% in one year? +/-10%? more?


1) If your time horizon is uncertain and you need stability and flexibility then a money market fund, savings account or short term GIC offers your only real options. Your rate of return will be significantly hindered. The best rate on these short term deposits is approximately 3% right now.

2) If you are confident that you won't see fundamental value for at least one year then you can clearly lock in for a 'good' rate on a GIC for at least one year. This has the advantage of keeping you disciplined but is much less flexible in terms of access to your money. The best rate on a 1 year GIC today was 3.90%. A 2 year GIC was 4.15%.

3) If you don't mind some mild fluctuation in your investments then a low cost bond fund such as the TD eSeries bond index fund could provide you with a decent coupon yield plus some potential upside if you think interest rates are going to fall before you purchase. If you have enough money some higher yielding corporate bonds can be purchased through a brokerage account. A quick search turns up several decent short term bonds with yields over 4%. Bonds have the advantage of being liquid so if you need access to the funds you will likely be able to get your money.

4) Equities - whether we are discussing an exchange traded fund, mutual fund, or an individual stock, be prepared for volatility. Even if you think you are investing in so-called safe securities, don't be fooled, a stock is a stock and the price of that stock is dependent on the perceived value of the corporation's earnings as seen by the buyers on that day. Your values may fluctuate violently and when it comes time to pull your money out, you may have less than you counted on. For a simple lesson on volatility, please look at the standard deviation of an investment before you purchase it. Bond funds have a low standard deviation because they are less volatile than equity funds.

I am not recommending one of these options over any other option but I hope the explanation is helpful. I don't recommend any allocation to equities higher than 30% for any time horizon shorter than 3 years and I don't recommend any allocation to equities higher than 45% for time periods shorter than 5 years.


VancouverGuy said...

To add to that sentiment, I would be scared of the TSX right now. The market has stayed up to a certain extent because we are resources focused, even where our diversified and financial stocks have tanked. With commodities potentially going south, I would definitley hold off on putting anything into the TSX. I am sitting on a ton of cash right now, and so are a lot of people I work with.

I think some US debt is well priced for the risk now... but I'm not recommending anyone go out and do that unless you actually have some credit analysis skills. There are some good credits with great security yielding a fantastic amount down there.

VancouverGuy said...

Oh, and more than 12 MOI for GV SFH!

Let's look for some accelerated tumbling in SFH next month... not that the 20%+ annualized drops in West Van, PoMo, Burnaby and South Delta weren't welcome already...

exvancouverite said...

Mohican, one of your pictures is on the Greater Fool blog. Thought that row of houses for sale in Langley looked familiar.
Great shot:)

skong said...

Actually, ING Direct advertises higher rates than you've stated:

1 Year 3.65%
2 Year 4.00%

that guy said...

for people with a horizon of 1 year or more, i think it's appropriate to hold a mix of cash, bonds, and equities ... depending on your risk tolerance. if you're unwilling to lose even $1, you should hold cash only. if you are willing to take on more risk than that, the amount allocated to bonds & equities should be based on your time horizon -- i'd suggest no more than 10% of the total should be allocated to bonds or equities for each year between now & when you plan to buy.

for personal reasons, i won't be buying for at least a year, so the current allocation of my down payment fund is:

75% cash
12.5% equities
12.5% bonds

the equity portion is divided equally between canadian, us, and EAFE index funds.

the bond portion is mostly invested in canadian index funds, with a small portion in corporate & foreign indexes.

the cash portion is split about evenly between CAD & USD (we might move to the US -- one of the many reasons we haven't already bought). most of the cash is held in ETRADE cash accounts (currently paying 3.05% on CAD balances, 3.3% for USD through ETRADE's US bank), and the Altamira "cash performer" fund (3.1% on CAD balances).

i hope others find this helpful.

mohican said...

skong - I think that 3.90% is higher than 3.65% and 4.2% is higher than 4%! But I'm just a financial planner, what do I know!

thatguy - good advice

mk-kids said...

thanks mohican for this topic & your sage advice, you too that guy... very helpful!


How do you feel about investing in a currency trader. Are there a lot of risks?

that guy said...

yes, currency trading is risky.

mightymouse said...

I called my Dad last night (he’s a CFO of large company abroad) to ask what he thought I should do with my money (I do this periodically), and the following is what he emailed to myself and my brother after the phone conversation:

*All names have been changed for anonymity reasons*

I had a brief chat with *Madcat today about stocks and interest rates and the fact that we are in a bear market and the US is in a recession. This bear market will probably last about 1 year. It is a fact that when interest rates go up stock prices go down. There is a huge credit problem in the USA. That is already causing the cost of borrowing (interest rates) to rise. This is because the banks are not lending money at the same pace as they were over the decade prior to mid - 2007. Instead they are using any money they can grab to clean up their balance sheets and eat bad debt losses which are astronomical due to the stupid credit decisions they have been making in the past. This is happening when the Fed Funds rate is lower than inflation. Pretty soon - not later than January 2009, the Fed is going to have to raise interest rates in order to pull excessive cash out of the system and to try to fight inflation. When that happens interest rates will rise across the board. That is not good for stocks.

Remember we are in a bear market and will likely remain there for another 9 - 12 months minimum. You will see the Dow and S&P500 have days where the Dow gains 300+ points and the S&P gains 30 or so points. These are called bear rallies or bear traps. No market ever moves steadily in the same direction. After a bear rally everybody who is lucky enough to still be employed by a mutual fund or stock broker will phone everyone in the continent of North America saying the market has turned around and today is the day to get in on the ground floor. Do not be sucked in by this. Remember WE ARE IN A BEAR MARKET. Keep your powder dry. That means stay in cash and make sure you owe no money on any credit cards.
- Dad

van_coffee said...

Mohican -
Do you have a copy of the Merrill Lynch Canada report that David Wolf put out? The one that keeps getting reference in the papers. If so, can you e-mail it to me.

mk-kids said...

Ok probably dumb question but is a GIC considered "cash"? Is there any risk with these?

that guy said...

i would consider a GIC "cash" -- although it is cash you can't spend until the end of the GIC's term. the main risk is inflation: money in a GIC earns a fixed (nominal) return. if the general price level rises (inflation) your real return declines. that is, the real value of the GIC (what you can buy with it) falls. similarly, if interest rates rise over the GIC's term, you miss out on the opportunity to earn a higher return on cash balances (you continue to earn the lower rate).

that guy said...

i should add that the main reason GICs pay a higher return than savings accounts (which have a variable interest rate) is to compensate you for the risk of rising prices and interest rates.

that guy said...

another note: the CDIC insures GIC deposits up to $100k, provided the GIC's term is 5 years or less. see here:

e8005 said...

Canadian Tire of all places offers a 4% 1-year GIC (for GIC investments of $20,000 and above):

mightymouse said...

Term GIC
1 Year 4.02%
2 Year 4.26%
3 Year 4.50%
4 Year 4.70%
5 Year 4.76%

mk-kids said...

thanks thatguy. so if you expect that interest rates will rise (as i do) in the next 6 months or so, a high interest savings account might pay as well or better than a gic and give more flexibility?

i used to have 3.5% on my high interest account but now its 2.5%

Warren said...

Hi mk-kids,

Etrade is offering 3.05% on their high interest cash account. There's no need to buy stocks or anything to open up an account with them. Although they did just get bought by Scotiabank's trading arm, so no promises on the future.

Anyway, I switched to them from ING a while back. ING used to be a market leader, but they seem to be a follower now.

I'd pick that rate over GICs any day, I prefer the flexibility and I think its worthwhile.