So I called my bank yesterday to move some savings for a house fund from a money market account to a CD. That’s my entire response to the current stock market plunge, now why and a brief primer on what to do. Through a series of questions. Note even with my Ph.D. in economics I have no special training in personal finance, I'm not your financial planner please consult a professional or better yet learn for yourself.
1. What's a CD? Any money with a major bank in a savings account up to 100,000 is insured by the FDIC. This includes CDs, which pay higher interest than savings account but require you to keep money in the account longer. If your Bank goes under the Federal Government will refund your money. What if all the banks go under? Then the money under your mattress is probably not worth much either.
2. Why move from a money market account to a CD?
A money market account is basically the safest thing short of a Federal Government guarantee. A money market invests in short term stable bonds. As Megan McArdle pointed out for only the second time in history a money market account has lost money, and it was only down 3%. We (my wife and I) are still contributing to my money market fund, but I’m going to hedge a little bit in case something crazy goes down. NPR has a good story on money markets here.
3. Why are you saving money in a money market account and a CD?
My wife and I plan to purchase a house in the next few years. As you can see from year to year who know what the stock marketing is going to do. If you are saving for something you will purchase within the next 5 years keep the money in a money market or CD, that way you expose yourself to less risk.
4. So you are thinking of buying a house, is it because it is a good time to buy?
The five year rule of thumb also applies to real estate, since prices can also vary a lot. The variation is less, but there is a large transaction cost to buying house. If you aren’t going to stay somewhere five years, it is not a good time to purchase. My wife and I both have good jobs now and think we’ll be in the area for a while, so it is a good time to buy for us, once we have a down payment we are comfortable with. If you think you may move or lose your job, don’t buy a house.
5. What about retirement?
Most of the people who read my blog are in their late 20s, except my parents and grandfather (but they don’t need money advice from me). So for us nearing 30 we have a lot of time left to go before retirement (35 plus years). Remember buy low, sell high. If the stock marketing is going down, think of it as everything is on sale. Most retirement advisers would recommend you stick with your general game plan and continue to purchase mostly stocks through a mutual fund (international and domestic), and some bonds (10%) ish to round out just in case. Many companies make this easy with target date retirement funds that do the balancing for you.
A great Warren Buffett story can be found here over at underlying logic.
So how did I learn this. Well as Yogi Berra once said you can observe a lot by just watching. I was lucky enough to have smart parents and grandparents, who passed on their knowledge. But I have also read a lot personal finance gurus. I recommend you go to your local library and pick a book that is right for you.
To find the right book, start with the Simple Dollar’s list of personal finance books, which recommends a book based on your personality.