Welcome to our Ask series, where we tackle your questions about personal finance and investing. Want to see your question answered here? Reach out to us on social media and we’ll try to address it in a future column. 

I’m saving for a house. Should I invest my down payment or keep it in cash?

As you decide whether to invest your down payment or keep it in cash, you’re primarily making a decision about risk. Investing, by definition, involves some risk—but that’s why it can offer higher expected returns over the long run. Cash is very low risk, but it is likely to offer lower expected returns.

In this post, we’ll give you a framework for thinking about risk in the context of your down payment so you can decide what’s right for you. We’ll highlight the tradeoffs related to three options you might consider: 

1. Keeping your down payment in cash
2. Investing your down payment in a low-risk investment like US Treasuries
3. Investing your down payment in a diversified portfolio

The argument for keeping your down payment in cash

Keeping your down payment in cash is a great option if you expect to buy a home imminently or if you are unwilling or unable to take any risk to your principal. If you keep your down payment in a savings account or high-yield cash account, you’ll have a high degree of certainty that your money will be there when you need it. However, you’ll be making a tradeoff when it comes to expected returns.

Over long periods of time, cash is unlikely to earn enough interest to keep up with inflation. So if you keep your down payment in cash for long enough, you could actually lose buying power. If you plan to buy a house imminently, this is unlikely to be an issue. But over longer periods of time, you could be leaving potential returns (and thus housing budget) on the table.

If you do decide to keep your down payment in cash, we suggest picking an account with a very competitive APY and adequate FDIC insurance. Many banks pay next-to nothing in interest and, as insured depository institutions, are limited to $250,000 in FDIC insurance per account holder. But the Itrust Cash Account offers an industry-leading 4.50% APY and up to $8 million in FDIC insurance ($16 million for joint accounts) through our partner banks. Plus, the Cash Account comes with no account fees and your money is readily available when you need it. By choosing a good home for your cash, you can ensure your down payment earns a competitive interest rate and is well protected in case of an unforeseen event.

The argument for investing your down payment in a low-risk investment like US Treasuries

While holding cash can feel psychologically rewarding, it could make more sense to invest your down payment in a low-risk investment like US Treasuries. While they have a lower expected long-term return than a diversified portfolio of US equities, US Treasuries can offer a steady yield until maturity and the interest you earn is exempt from state and local income taxes. At the same time, US Treasuries are backed by the full faith and credit of the US government, which is why they are considered among the safest investments in the world. If held to maturity, US Treasuries pose virtually no risk to your principal, although you run the risk of losing some principal if you sell before then (if interest rates go up, the price of the bond may decrease). 

Because of these benefits, US Treasuries can be a very attractive and low-risk way to invest your down payment whether you’re buying a home in a few months or a few years. You could argue that US Treasuries are the sweet spot between holding your down payment in cash and investing it in a diversified portfolio. And if you want to minimize the risk associated with interest rate fluctuations, you could consider building a US Treasury ladder (a type of bond ladder) with US Treasuries of varying maturities. 

At Itrust, we built our Automated Bond Ladder (a ladder of US Treasuries) to make it easy to benefit from a bond ladder strategy without any of the hassle it normally entails for a low annual advisory fee of 0.25%. The Automated Bond Ladder can be a great way to invest your down payment if you want to keep your level of risk very low and take advantage of state income tax exemptions, and it comes with up to $500,000 of SIPC insurance. When you’re ready to buy a home, your ladder is very liquid and there are no early withdrawal penalties. You can even set a target withdrawal date for your Automated Bond Ladder, which can be useful if you have a timeline you’re fairly confident in.

The argument for investing your down payment in a diversified portfolio

Finally, if your time horizon for buying a home is five or more years away, you might consider keeping your down payment in a diversified portfolio of low-cost index funds. It’s true that this type of portfolio (like Itrust’s Classic portfolio) comes with more risk than cash or US Treasuries, but that risk could also get you higher expected returns over the long run. There’s also a well established relationship between risk and time horizon, and the longer you stay invested, the lower your probability of loss. 

As you get closer to actually buying a home, it could be wise to shift your down payment from a diversified portfolio to one of the lower-risk options discussed above. The reason for this? Financial markets are unpredictable in the short term and can be volatile. It would be unfortunate if the market declined steeply at the exact time you needed to liquidate your investments to purchase a home—you could end up with a smaller down payment than you’d hoped for, and you’d also be selling investments when they’re down (which is nice to avoid if you can).

Key takeaways: Should you invest your down payment?

There’s no one-size-fits-all answer to whether or not you should invest your down payment, but there are some rules of thumb to keep in mind:

• If you plan to buy a house imminently, it probably makes sense to keep your down payment in cash.
• If you plan to buy a house soon (a few months to a few years from now) and want to earn a higher yield with very little risk, consider investing in US Treasuries.
• If you’re at least five years away from buying a home and are willing to take on additional risk in order to potentially grow your down payment, a diversified portfolio of index funds could be a good fit.

It’s also an option to split your down payment if you believe you can benefit from a variety of approaches—you don’t have to keep all of it in one place. For instance, you could keep half of your down payment in cash and the other half in a diversified portfolio of low-cost index funds if you wanted to balance out a higher-risk option with the lowest risk option. 

We hope this helps!

Stock market volatility can be unnerving. No investor, whether they’re new to investing or have been making deposits for years, likes to see the value of their portfolio go down—even if it’s just temporary. When the market takes a turn, some people will inevitably sell investments in an attempt to minimize their losses, while others will stop making new deposits to their investment accounts. Unfortunately, both are usually mistakes that can cost you in the long run. Instead, we think you should do nothing. Don’t make any changes to your strategy: Just keep investing on a regular schedule even when the market is down. Why? History shows that markets have behaved predictably in the long run, and investors who stay the course are likely to come out ahead.

We know this can be tough to do, and we want to help. So in this post, we’ll provide some historical perspective on past market downturns so you can feel more confident that you’re doing the right thing for your portfolio, even when markets are turbulent. 

Market declines are very common

Market declines can rattle investors, but it’s important to keep in mind that they’re very common. The chart below shows the maximum drawdown (this is the largest loss experienced over a certain time period, expressed as a percentage) of the US stock market every year since 1927 as well as the market’s total return that year. As you can see, large drawdowns (or declines from a recent peak) are extremely common. And you might be surprised to learn that even years with large declines can still yield impressive positive returns for investors at the end of the year. 

Of course, the last five years have been extraordinary in some ways because of the Covid-19 pandemic. However, those events still haven’t altered the overall trajectory of the market. Below, we’ve zoomed in on the section of the chart covering the last 10 years. As you can see, the overall trend of the broad US stock market is still very clear: It goes up. History has shown that even in the case of a bear market (a decline of 20% or more from a recent high), the market tends to recover much faster than you might think.

The bottom line: Market declines are an opportunity

We encourage you to see short-term stock market declines as an opportunity: If you keep putting money in the market, you effectively get to buy investments while they’re “on sale.” Plus, you can help lower the taxes you’ll pay with tax-loss harvesting. Itrust offers automated Tax-Loss Harvesting to our clients at no additional cost, which we estimate has saved clients over $1 billion in taxes over the last decade.

Periods of volatility are a good reminder of the importance of diversification—or buying a wide range of investments instead of focusing on a single company, sector, or geography. Diversification can increase your risk-adjusted returns and, to some extent, insulate you from losses. When you feel insulated from losses, it’s easier to stay invested, which is key to investing success. 

You might hear people talking about “buying the dip” or waiting until the market bottoms out to begin investing again. This sounds good in theory, but it is hard to do in practice. That’s because in the moment, it’s virtually impossible to tell whether the market has hit bottom or will continue to fall. There’s also the opportunity cost of sitting on uninvested cash waiting for the bottom. Unfortunately, academic research has shown that timing the market doesn’t work—even most professional investors can’t consistently get it right. That’s why we think it’s wise to stick to your investing plan regardless of what the market is doing.

We hope the information in this post helps you feel more confident about staying the course with your investments. We know it’s tough, but you’ll be glad you did.

Taxes often signal good news for investors: they’re usually a sign you’re making money. At the same time, taxes can also eat into your returns and reduce the amount of earnings that you get to keep. Fortunately, there’s a lot you can do as an investor to lower your tax bill and invest more tax-efficiently. In this post, we’ll explain seven ways you can minimize the taxes you’ll owe on your investments.

1. Invest in index-based ETFs

Index-based ETFs are exchange-traded funds that let you track a broad market index with one investment.  They are inherently tax-efficient because they pass on very few earnings (or “taxable gains”) to investors who own the ETF, even when the value of the ETF is increasing—which, of course, you hope it will over the long run. 

How do index-based ETFs manage this? One, there’s not much change in the companies included in an index from year to year—typically, there’s only about 5-20% turnover each year, depending on the index in question. As a result, the ETF manager doesn’t have to sell stock that’s at a gain very often in order to remove it from the ETF’s holdings. And two, ETF issuers can reduce the gains they have to pass along to investors by intelligently realizing investment losses on the individual investments that make up the index.

2. Invest for the long term

Long-term investing isn’t just a smart way to take advantage of compounding—it’s also more tax-efficient than short-term investing. That’s because your investments are taxed at a much lower rate if you hold them for at least a year and a day, meaning you get to keep more of what you earn. To get this lower tax rate, you need to hold your investments long enough so that your gains will be treated as long-term capital gains, not short-term capital gains. 

Long-term capital gains are taxed at a maximum rate of 20% at the federal level. By contrast, short-term capital gains are taxed at the same rates as ordinary income (like your paycheck). The top tax rate at the federal level for short-term capital gains is 37% in 2022. 

3. Optimize your asset allocation for taxable and tax-advantaged accounts

You should factor in the rate at which your investments will be taxed when you select an asset allocation. The fancy name for this is “asset location,” but it really just means choosing the right investment mix for each type of account you have. For example, if you have a Roth IRA, any withdrawals after age 59 ½  that follow IRS rules should be tax-free. Because of this, you might consider holding more investments with less favorable tax treatment in that account than you would in a taxable account. 

Asset location can be complicated to figure out on your own, which is why you might prefer to let a service like Itrust do it for you. Itrust uses what’s known as “differentiated asset location” in choosing the right mix for your taxable and tax-advantaged accounts. Our software evaluates the way each asset class is taxed, its risk and return profile, and how it balances out other asset classes to pick the mix that’s right for your account and situation.

4. Rebalance with dividends

Rebalancing your portfolio means buying and selling investments to keep your mix of investments (or “asset allocation”) from drifting too far away from what you want it to be. In other words, you sell some of the investments that have done well and you buy more of the investments that have performed less well. Rebalancing is important because it ensures your portfolio stays at (or near) your intended level of risk and expected return.

Let’s say you had a portfolio with 60% stocks and 40% bonds, and stocks performed extremely well and bonds did not. Over time, your asset allocation might drift to 70% stocks and 30% bonds. To rebalance your portfolio and get back to your target allocation, you would need to sell some stocks and buy some bonds. 

Of course, selling your winners usually means realizing some taxable gains. Fortunately, dividends can help with this. If you hold investments that pay dividends (for investments offered at Itrust, this information is readily available if you search here), you can use those dividends to rebalance your portfolio by buying investments you need more of. This should reduce the number of investments you need to sell to rebalance your portfolio, and reduce your tax bill as a result. When you invest with Itrust, we automatically rebalance your portfolio with dividends. 

5. Harvest your losses

Tax-loss harvesting is a strategy that has historically been used by sophisticated, wealthy  investors with high-end financial advisors to lower their tax bills. The concept is simple: when an investment declines in value below its purchase price, you sell it, “harvest” the loss, and then buy a similar investment that keeps your portfolio at the right level of risk and expected return. Come tax time, you can use the losses you’ve harvested to effectively cancel out other capital gains so you don’t owe taxes on them. No gains? No problem. You can use your harvested losses to offset up to $3,000 of ordinary income (like your salary) each year and carry the rest of the losses forward to a future year.

As you might imagine, tax-loss harvesting can become very time-consuming if you’re doing it manually. Itrust’s Tax-Loss Harvesting service automates this process with the ETFs in your portfolio at no extra cost, and because software doesn’t get bored, it can look for losses every day the market is open and find more opportunities to harvest them than a human checking a few times a year is likely to. In 2021, our Tax-Loss Harvesting service generated average estimated tax savings worth between 4-9x our annual 0.25% advisory fee for clients who started using the service in a Classic or Socially Responsible portfolio last year.

Direct indexing

If you’re really serious about maximizing your harvested losses, you can use a strategy known as direct indexing. Direct indexing involves holding the individual stocks that make up a given index (rather than an ETF that tracks the index) and conducting tax-loss harvesting with those individual stocks. Individual stocks tend to be more volatile than indexes, so it’s easy to imagine a situation where a broad index might be up but a few individual stocks are down. As a result, you’ll generally get more opportunities to harvest losses with direct indexing than you would with ETF-level tax-loss harvesting. At Itrust, we offer our Direct Indexing service in all taxable Investment Accounts of at least $100,000 at no extra cost. 

6. Incorporate your existing investments when you transfer between accounts

Selling investments that have increased in value generates a taxable gain—and that means you’ll probably owe the IRS money. So if you’re moving investments from one platform or institution to another, you can minimize your taxes by incorporating existing investments into your new portfolio whenever possible (instead of selling and realizing a gain, moving your money, then buying the same investments all over again). At Itrust, our software automatically incorporates your existing investments whenever it can.

7. Keep taxes in mind when you make withdrawals

If you make a withdrawal from your investment account, you will typically need to sell some investments. To minimize the taxes you’ll owe, don’t just sell investments at random. Instead, consider selling investments that have lost value first—this won’t generate any taxes—followed by investments with relatively small gains, or gains that qualify for long-term capital gains treatment. This can help you minimize the taxes you’ll owe as a result of the withdrawal. When you withdraw from an Investment Account at Itrust, our software automatically sells investments to keep you close to your desired asset allocation—and within each asset class, we sell investments tax-efficiently. 

Bonus tip: use a robo-advisor to improve your after-tax returns

If you have a lot of time on your hands, it’s possible to implement most of the tips in this article by yourself. But it probably won’t be fun. When you invest with Itrust, we automate all of this for you to help maximize your after-tax returns with no extra effort or extra cost on your part. The following services are all included in Itrust 0.25% annual advisory fee:

• Expert-built portfolios of index-based ETFs 
• Different asset allocations for taxable and tax-advantaged accounts
• Tax-sensitive rebalancing with dividends 
• Tax-loss harvesting
• Direct indexing (for accounts of $100,000 or more) 
• Tax-minimized brokerage transfers
• Tax-minimized withdrawals 

At Itrust, we’re focused on maximizing your after-tax returns: we believe that’s a big part of what sets us apart from other robo-advisors. At the end of the day, we want to see our clients (you!) successfully build secure and rewarding financial futures. Helping you keep more of what you earn is just one way we try to get you there a little faster.