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Backdoor Roths and beyond: The four camps who can benefit
Roth IRA conversions can unlock serious savings, especially if you find yourself in one of these scenarios.
Backdoor Roths and beyond: The four camps who can benefit true Roth IRA conversions can unlock serious savings, especially if you find yourself in one of these scenarios. Roth IRAs and their tax-free perks are pretty great—so great that in some scenarios, it can make sense to convert pre-tax dollars from traditional retirement accounts into post-tax dollars in a Roth IRA. This is what’s known as a Roth conversion. You’re effectively taking those pre-tax funds and telling Uncle Sam you’d rather pay taxes on them now in exchange for the benefit of tax-free and penalty-free withdrawals in retirement. And if you need the money earlier, the IRS requires only that you wait five years before withdrawing each conversion to avoid a 10% penalty. So who do Roth conversions appeal to in particular? Four types of people: High earners and the “backdoor” Roth conversion Recent retirees and unwelcome RMDs Early retirees and the Roth conversion “ladder” People experiencing temporary income dips High earners and the “backdoor” Roth conversion Did you know the IRS restricts access to Roth IRAs based on income? Shut the front door! Yes, if your income exceeds these eligibility limits, you can’t contribute directly to a Roth IRA. But as the saying goes, when one door closes, another door opens. A “backdoor,” more specifically. So if you make too much money, fear not – you can contribute indirectly to a Roth IRA via a Roth conversion widely known as a “backdoor” Roth. This entails contributing post-tax dollars first to a traditional IRA, then converting those funds to a Roth IRA. If you’ve never contributed to a traditional IRA before, pulling off a backdoor Roth can be simple, especially if you use Betterment. Open both a traditional and Roth IRA with us, fund the traditional, then convert those funds to your Roth IRA once they’ve settled. Done! If you have any existing traditional IRA funds, however, things get a little more complicated due to something called the pro rata rule. In short, you need to move any pre-tax dollars out of your traditional IRA(s) into an employer-sponsored retirement account like a 401(k) before you can use the account as a backdoor. This gets even more complicated if you have both pre- and post-tax dollars mixed together in your traditional IRA(s). Before going down the road of a backdoor Roth conversion, or any Roth conversion really, we highly recommend seeking the advice of a financial advisor, as well as a tax advisor in certain cases. They can help assess both your current situation and future projections. Recent retirees and unwelcome RMDs The IRS doesn’t let you keep funds in your traditional retirement accounts indefinitely. They’re meant to be spent, after all. So starting at age 73, annual required minimum distributions (RMDs) from these accounts kick in. RMDs aren’t inherently a bad thing, but if your expenses can already be covered from other sources, RMDs will just raise your tax bill unnecessarily. You can get ahead of this and lower your future amount of RMDs by converting traditional account funds to a Roth IRA before you reach RMD age. That’s because Roth IRAs are exempt from RMDs. And as an added benefit, you’ll minimize taxes on Social Security benefits and Medicare premiums later on in retirement. Just make sure you convert those funds before you turn 73, because once RMDs kick in, those amounts can’t be converted. Early retirees and the Roth conversion “ladder” If you want to retire early, even by “just” a few years, you very well might encounter a problem: Most of your retirement savings are tied up in tax-advantaged 401(k)s and IRAs, which slap you with a 10% penalty if you withdraw the funds before the age of 59 ½. A few exceptions to this early withdrawal rule exist, the biggest for early retirees being that contributions to a Roth IRA (i.e., not the gains you may see on those contributions) can be withdrawn early without taxes or penalties, in this specific order: “Regular” contributions made directly to a Roth IRA. As an aside, you can always withdraw these funds tax-free and penalty-free without waiting five years. Once you’ve burned through regular contributions, the IRS allows you to withdraw contributions that were converted from traditional 401(k)s and traditional IRAs! You won’t pay any additional taxes on these withdrawn contributions because taxes have already been paid. But withdrawn conversions (item #2 above) typically are still subject to a 10% penalty if withdrawn before 5 years. Think of this rule as a speed bump in an otherwise swift shortcut. So what does all of this mean for early retirees? Starting five years before they plan on retiring, they can create a “ladder” looking something like the table below (note: dollar amounts are hypothetical). They convert funds each year, pay taxes on them at that time, then withdraw them five years later 10% penalty-free and sans any additional taxes. Time Amount converted Amount withdrawn Source of withdrawal 5 years pre-retirement $40,000 $0 N/A 4 years pre-retirement $40,000 $0 N/A 3 years pre-retirement $40,000 $0 N/A 2 years pre-retirement $40,000 $0 N/A 1 year pre-retirement $40,000 $0 N/A Retired early! 🎉 Year 1 of retirement $40,000 $40,000 5 years pre-retirement Year 2 of retirement $40,000 $40,000 4 years pre-retirement Year 3 of retirement $40,000 $40,000 3 years pre-retirement Year 4 of retirement $40,000 $40,000 2 years pre-retirement Year 5 of retirement $40,000 $40,000 1 year pre-retirement Etc. Etc. Etc. Etc. People experiencing temporary income dips Say you find yourself staring at a significantly smaller income for the year. Maybe you lost your job. Maybe you work on commission and had a down year. Or maybe you had a big tax writeoff. Whatever the reason, that dip in income means you’re currently in a lower tax bracket, and it may be wise to pay taxes on some of your pre-tax investments now at that lower rate compared to the higher rate when your income bounces back. Watch out for potential Roth conversion pitfalls Each of these scenarios requires careful tax planning, so again, we recommend working with a trusted financial advisor and/or tax advisor. They can help you avoid the most common Roth conversion mistakes and take full advantage of this post-tax money maneuver. Our CERTIFIED FINANCIAL PLANNER™ professionals are here to offer on-demand guidance. -
Three steps to size up your emergency fund
Strive for at least three months of expenses while taking these factors into consideration.
Three steps to size up your emergency fund true Strive for at least three months of expenses while taking these factors into consideration. Imagine losing your job, totaling your car, or landing in the hospital. How quickly would your mind turn from the shock of the event itself to worrying about paying your bills? If you’re anything like the majority of Americans recently surveyed by Bankrate, finances would add insult to injury pretty fast: 57% | Percentage of U.S. adults currently unable to afford a $1,000 emergency expense In these scenarios, an emergency fund can not only help you avoid taking on high-interest debt or backtracking on other money goals, it can give you one less thing to worry about in trying times. So how much should you have saved, and where should you put it? Follow these three steps. 1. Tally up your monthly living expenses — or use our shortcut. Coming up with this number isn’t always easy. You may have dozens of regular expenses falling into one of a few big buckets: Food Housing Transportation Medical When you create an Emergency Fund goal at Betterment, we automatically estimate your monthly expenses based on two factors from your financial profile: Your self-reported household annual income Your zip code’s estimated cost of living You’re more than welcome to use your own dollar figure, but don’t let math get in the way of getting started. 2. Decide how many months make sense for you We recommend having at least three months’ worth of expenses in your emergency fund. A few scenarios that might warrant saving more include: You support others with your income Your job security is iffy You don’t have steady income You have a serious medical condition But it really comes down to how much will help you sleep soundly at night. According to Bankrate’s survey, nearly ⅔ of people say that total is six months or more. Whatever amount you land on, we’ll suggest a monthly recurring deposit to help you get there. We’ll also project a four-year balance based on your initial and scheduled deposits and your expected return and volatility. Why four years? We believe that’s a realistic timeframe to save at least three months of living expenses through recurring deposits. If you can get there quicker and move on to other money goals, even better! 3. Pick a place to keep your emergency fund We recommend keeping your emergency fund in one of two places: cash—more specifically a low-risk, high-yield cash account—or a bond-heavy investing account. A low-risk, high-yield cash account like our Cash Reserve may not always keep pace with inflation, but it comes with no investment risk. An investing account is better suited to keep up with inflation but is relatively riskier. Because of this volatility, we currently suggest adding a 30% buffer to your emergency fund’s target amount if you stick with the default stock/bond allocation. There also may be tax implications should you withdraw funds. Your decision will again come down to your comfort level with risk. If the thought of seeing your emergency fund’s value dip, even for a second, gives you heartburn, you might consider sticking with a cash account. Or you can always hedge and split your emergency fund between the two. There’s no wrong answer here! Remember to go with the (cash) flow There’s no final answer here either. Emergency funds naturally ebb and flow over the years. Your monthly expenses could go up or down. You might have to withdraw (and later replace) funds. Or you simply might realize you need a little more saved to feel secure. Revisit your numbers on occasion—say, once a year or anytime you get a raise or big new expense like a house or baby—and rest easy knowing you’re tackling one of the most important financial goals out there. -
How donating shares can help you save on taxes
Donating shares lets you avoid paying taxes on capital gains, and you can still deduct the value of your gift on your tax return.
How donating shares can help you save on taxes true Donating shares lets you avoid paying taxes on capital gains, and you can still deduct the value of your gift on your tax return. In 1 minute There are many different ways for you to give back to your community. For example, giving directly to individuals in poverty, donating cash to charities, and volunteering your time are all well-known and worthwhile options. As an investor, you may have access to an option that comes with significant potential advantages: You can donate qualifying appreciated shares—or in other words, shares that are worth more today than when you acquired them. When you donate in the form of cash, you can deduct the value of that donation on your tax return. And that’s great! But by donating cash, you could be missing out on an additional tax incentive. Donate appreciated shares instead, and you could also avoid paying taxes on capital gains. That means your donation goes further while spending the same amount. And yes, you still get to deduct the value of those gifted shares on your tax return—as long as you’ve held them for at least a year. However, you should be aware that the deduction may not be exactly the same value. The IRS calculates the tax-deductible value of those shares as the average of the highest price and the lowest price on the day you made the transfer. Sometimes that means the deductible value ends up being slightly lower than the exact value you donated. Other times it ends up being slightly higher, giving you yet another benefit! But either way, the amount you save by avoiding the capital gains tax can exceed the differences in valuation. Consider if boosting your charitable giving by donating shares is right for you. In 5 minutes In this guide, we’ll: Explore donating shares instead of cash Explain how the IRS calculates these deductions Show you how Betterment makes donating shares easy You’ve been investing, planning for your future and becoming financially secure, and you’d like to pay it forward. That’s great! There are many ways to give back to your community. You might donate to charitable organizations. You might give cash directly to those in need. Or you might give of your time by volunteering. As an investor, you have a charitable super power. You can make your gifts go further and enjoy tax benefits at the same time. Why you should consider donating shares instead of cash When you have assets that have gained value, donating cash means you may not be making the most of your gift. Donations in the form of eligible shares offer two main advantages: You won’t pay capital gains taxes on the shares you donate You can deduct the value of your gift on your tax return Since you get more tax benefits, your money can stretch further. You have more left over to donate, invest, or use as you see fit. How the IRS calculates these deductions When you donate a share, you do so at a certain point in time, with an associated price. For greatest tax efficiency, you generally should only donate shares you’ve held for at least one year1. At that point, the IRS lets you claim a deduction for the whole, appreciated value up to 30% of adjusted gross income. However, the price at the time of your gift isn’t necessarily the same value that’s deducted on your tax return. The IRS rules say the deductible amount for your tax filing must be the “fair market value.” And the IRS determines the fair market value by taking the average of the highest price and lowest price on the day of the transfer. Say you donate $1,000 worth of shares: 20 shares worth $50 each. During the day of your donation, the shares trade at a high price of $51 and a low of $47. The IRS will call the fair market value of all twenty shares $980. That $980 is the deductible value when you file your taxes for the year. So keep in mind that the value you plan to donate won’t necessarily match the exact value you can deduct on your taxes. However, while the numbers may be slightly lower or higher than you initially expect, the value of saving on capital gains tax by donating appreciated shares and then being able to deduct that value to lower your taxes even further, generally exceeds any differences in valuation during the day of transfer. Betterment makes donating shares easy We believe that donating securities should be as easy as donating cash. You’re trying to make a difference. You shouldn’t have to worry about math or forms. No snail mail. No walking into an office. So we streamlined the process. Here’s how: We track how much of your account is eligible to give to charity. Betterment automatically reports the amount eligible for donation, assessing which shares of your investments have been held for more than one year, and which of those have the most appreciation. We estimate the tax benefits of your gift. Before you complete a donation, we’ll let you know the expected deductible amount and potential capital gains taxes saved. We move assets from your account to a charitable organization’s account. No paperwork! With a traditional broker, your gift would have to move from your account to the organization’s brokerage account, which involves time and paperwork. But Betterment offers charities investment accounts with no advisory fees—on up to $1 million of assets—to make the gift process seamless. We provide a tax receipt once the donation is complete. We’ll email the receipt to you, and you’ll also be able to access it from your Betterment account at any time. Additionally, we take on most of the reporting for our partner charities, letting them devote their resources more efficiently to the causes you support, rather than to administrative tasks. We partner with highly-rated charities across a range of causes. These include nonprofits such as the World Wildlife Fund, Boys and Girls Clubs of America, and Givewell. Log in to your Betterment account to see the full list. Don’t see your preferred charity? Put in a request to add them! Gifting securities to charity, rather than donating cash, is a strategy that wealthy philanthropists have been employing for decades to save on capital gains taxes. We hope to democratize these benefits by helping everyday Americans use the same exact tax-saving method. If you decide it’s right for you, join our community of altruistic investors today and make the most of your charitable donations! If you’re already a Betterment customer, log in to donate your appreciated shares. 1IRS Publication 526, pg. 11-12
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Save more, sweat less with recurring deposits
Save more, sweat less with recurring deposits How one click—and the power of dollar cost averaging—can boost your returns Healthy habits like exercising, eating well, and saving are hard for a reason. They take effort, and the results aren’t always immediate. Except in the case of saving, there’s a simple hack that lowers the amount of willpower needed: setting up recurring deposits. So kick off those running shoes, because you barely have to lift a finger to start regularly putting money into the market. $2, $200, it doesn’t matter. This one deposit setting, along with a little help from something called dollar cost averaging, can lead to better returns. Our own data shows it: Over the last decade, customers who used recurring deposits earned 6% higher annual returns than those who didn’t. *Based on Betterment's internal calculations for the Core portfolio. Users in the "auto-deposit on" groups earned an additional 1% annualized over 5 years and 6% over the last year. See more in disclosures. Three big reasons they fared better than those who rarely used recurring deposits include: When you set something to happen automatically, it usually happens. It's relatively easy to skip a workout or language lesson. All you need to do is … nothing. But the beauty of recurring deposits is it takes more energy to stop your saving streak than sustain it. When you regularly invest a fixed amount of money, you're doing something called dollar cost averaging, or DCA. DCA is a sneaky smart investment strategy, because you end up buying more shares when prices are low and fewer shares when prices are high. A steady drip of deposits helps keep your portfolio balanced more cost-effectively. Instead of selling overweighted assets and triggering capital gains taxes, we use recurring deposits to regularly buy the assets needed to bring your portfolio back into balance. Now it’s time for an important caveat: The benefits of dollar cost averaging don't apply if you have a chunk of money lying around that’s ripe for investing. In this scenario, slowly depositing those dollars can actually cost you, and making a lump sum deposit may very well be in your best interest. But here’s the good news: While DCA and lump sum investing are often presented in either/or terms, you can do both! In fact, many super savers do. You can budget recurring deposits into your week-to-week finances—try scheduling them a day after your paycheck arrives so you’re less likely to spend the money. Then when you find yourself with more cash than you need on hand, be it a bonus or otherwise, you can invest that lump sum. Do both, and you may like what you see when you look at your returns down the road. -
The savvy saving move for your excess cash
The savvy saving move for your excess cash And why taking the “lump sum” leap may be in your best interest We're living in strange financial times. Inflation has taken a huge bite out of our purchasing power, yet investors are sitting on record amounts of cash, the same cash that's worth 14% less than it was just three years ago. High interest rates explain a lot of it. Who wouldn't be tempted by a 5% yield for simply socking away their money? But interest rates change, and we very well could be coming out of a period of high rates, leaving some savers with lower yields and more cash than they know what to do with. So let's start there—how much cash do you really need? Then, what should you do with the excess? How much cash do you really need? Cash serves three main purposes: Paying the bills. The average American household, as an example, spends roughly $6,000 a month. Providing a safety net. Most advisors (including us) recommend keeping at least three months' worth of expenses in an emergency fund. Purchasing big-ticket items. Think vacations, cars, and homes. Your spending levels may differ, but for the typical American, that's $24,000 in cash, plus any more needed for major purchases. If you're more risk averse—and if you're reading this, you just might be—then by all means add more buffer. It's your money! Try a six-month emergency fund. If you’re a freelancer and your income fluctuates month-to-month, consider nine months. Beyond that, however, you're paying a premium for cash that’s not earmarked for any specific purpose, and the cost is two-fold. Your cash, as mentioned earlier, is very likely losing value each day thanks to inflation, even historically-normal levels of inflation. Then there's the opportunity cost. You're missing out on the potential gains of the market. And the historical difference in yields between cash and stocks is stark, to say the least. The MSCI World Index, as good a proxy for the global stock market as there is, has generated a 8.5% annual yield since 1988. High-yield savings accounts, on the other hand, even at today’s record highs, trail that by a solid three percentage points. So once you've identified your excess cash, and you’ve set your sights on putting it to better use, where do you go from there? What should you do with the excess? Say hello to lump sum deposits. Investing by way of a lump sum deposit can feel like a leap of faith. Like diving into the deep end rather than slowly wading into shallow waters. And it feels that way for a reason! All investing comes with risk. But when you have extra cash lying around and available to invest, diving in is more likely to produce better returns over the long term, even accounting for the possibility of short-term market volatility. Vanguard crunched the numbers and found that nearly three-fourths of the time, the scales tipped in favor of making a lump sum deposit vs. spreading things out over six months. The practice of regularly investing a fixed amount is called dollar cost averaging (DCA), and it’s designed for a different scenario altogether: investing your regular cash flow. DCA can help you start and sustain a savings habit, buy more shares of an investment when prices are low, and rebalance your portfolio more cost effectively. But in the meantime, if you’ve got excess cash, diving in with a lump sum deposit makes the most sense, mathematically-speaking. And remember it’s not an either-or proposition! Savvy savers employ both strategies—they dollar cost average their cash flow, and they invest lump sums as they appear. Because in the end, both serve the same goal of building long-term wealth. -
How tax loss harvesting can give your taxable investing an edge
How tax loss harvesting can give your taxable investing an edge The tax strategy can unlock similar benefits as tax-deferred accounts Tax loss harvesting, or TLH for short, is the act of selling an asset at a loss, then quickly replacing it with a similar one—primarily to offset taxes owed on capital gains or income. In practice, it lowers your taxes now and increases them later. But don’t freak out, because the key takeaway of TLH is this: TLH can take a portion of your taxable investing and effectively turn it into tax-deferred investing. And tax-deferred investing, as we’ll quickly demonstrate, can do wonders for wealth-building. Tax me now or tax me later Take a dollar you would’ve otherwise paid in taxes today. Now invest it wisely. Odds are, it’ll be worth a lot more in the long run, even taking away any taxes you eventually owe. Depending on how your tax situation shakes out over the years, tax-deferred investing can be like Uncle Sam giving you a nearly interest-free loan to invest. This is in large part why tax-deferred accounts like traditional 401(k)s and IRAs come with restrictions. They’re reserved for retirement, namely, and their contributions are capped. But tax loss harvesting opens an entirely new door for tax-deferred investing, along with a few other side benefits. For a few types of investors in particular, it offers tremendous upside. Who TLH benefits the most Let’s start with an important caveat: While TLH offers potential value for most investors, it can be a wash or actually increase your tax burden in certain cases. But for now, let’s focus on three types of investors who can reap some of the biggest rewards from the strategy: The high-income earner Once you’ve offset all of your realized capital gains taxes for a given year, any leftover harvested losses can be used to offset taxes on up to $3,000 of ordinary income. So in the case of high earners, this means trading a high income tax rate for a relatively low long-term capital gains tax rate. The end result is both deferring and discounting your taxes. The steady saver Not only are recurring deposits a great way to start a savings habit, they also produce more harvesting opportunities. That’s because the older an investment, the less likely it drops below its initial purchase price (aka “cost basis”) and can be harvested at a loss. A steady drip of deposits, monthly for example, creates fresh crops of investments for harvesting in the near future. The tax-smart philanthropist A common misconception of tax loss harvesting is that it helps you avoid paying taxes altogether. Believe it or not, however, two scenarios exist in which you actually can cancel out your tax obligation: The first is when you donate shares to charity. As we mentioned earlier, selling and replacing shares as part of a harvest increases their future tax bill. It does this by lowering the shares’ cost basis, or the initial purchase price used to calculate capital gains. If you donate and replace these shares down the road, however, you reset their cost basis to a new, higher level. This effectively wipes out their entire tax bill(!) that had accrued to that point. In the eyes of the IRS, it’s like those capital gains never happened, and it’s one big reason why wealthy investors have long paired TLH with the practice of donating shares. The second scenario is posthumously. At that point, you won’t get a tax break, of course. But any individuals who you leave shares to will, because immediately after your death, the cost basis of your investments similarly “steps up” to their current market value. Your harvest awaits Historically-speaking, tax loss harvesting has been too time-intensive and costly to execute for all but the wealthiest of investors. But technology like ours and the low-cost trading of ETFs have made it a tax strategy for the masses. If TLH is right for you, the sooner you open and start contributing to a taxable account, the sooner you can start giving a portion of your taxable investing an edge. If you already have a Betterment taxable account, here’s how to turn on tax loss harvesting. -
How to talk money with your aging parents
How to talk money with your aging parents Talking about their financial future isn’t easy, but it’s important Talking money with your parents is no one’s idea of a good time. But as you enter middle age, and they enter their Golden years, it’s important to create an open dialogue. Because one day, you could be pressed into duty helping them manage their finances, or even stepping in with financial support yourself. Pew Research Center polled adults with an aging (65+) parent and found it’s more common than you might think. So before you buy another bouquet of flowers, or another tacky tie, consider gifting your parents an awkward but meaningful conversation on money’s role in aging with grace. Here's how. Step into their shoes, then switch mindsets If you think it's hard having this “talk” with your parents, imagine how they must feel. Maybe they're afraid their money won't last. Maybe they're too embarrassed to ask for help. From anyone, let alone someone whose diaper they once changed (and changed, and changed). This sort of empathy sets the stage for a true heart-to-heart. Sure, you could share any number of practical tips—everything from catch-up contributions and safe withdrawal strategies to (quick plug) how awesome Betterment is and how easy it is to switch—but those conversations are best left for another day. What matters most in these first few exchanges is to build trust, and to come at things through the lens of curiosity, not problem-solving. To that end, we leave you with a few suggestions. Three ways to set the table, and three icebreaker ideas Depending on your relationship with your parents, there may be no way around this: It will be awkward. Your inquiries may be met with resistance. So start getting comfortable with both possibilities. A few tips can help your odds: Pick a boring time. Steer clear of hectic holidays. Start small. Spread things out over multiple conversations. Stay curious. The questions matter more than the answers. Now, once it’s time to actually start the conversation, consider a few icebreakers: The “23andMe” angle. “I’m curious, how did your parents handle their finances as they aged? Did you ever talk about it with them?” The “I’ll go first” angle. “With the kids getting older, I’ve been thinking more and more about estate planning lately. But it’s all so overwhelming.” The CNBC angle. “Did you see the Dow just dropped [insert number] points? I know it’s easy to overreact, but it stings seeing my portfolio shrink even just a little.” Regardless of where things go from here, remember to give yourself credit. You just took the hardest step (the first one) in joining your parents on their financial journey. And if there ever does come a day when they consider joining you at Betterment, our team is here to help. -
The keys to building wealth, whether you rent or buy
The keys to building wealth, whether you rent or buy There's more than one path to prosperity To rent or to buy. At some point in your life, adulting may very well boil down to this one anxiety-inducing question. But it’s really two questions wrapped in one. The first is highly-personal: “Which lifestyle is right for me, right now?” And that answer is totally up to you. It’s largely based on individual circumstance, personal preference, and how much time you can handle at The Home Depot. But the second question? It deals with dollars and cents, and it’s right up our alley. So we’re here to offer you a sigh of relief, then help you turn hypotheticals into concrete action. Is renting or buying your primary residence the smarter money move? We’re in the business of building long-term wealth, and on that topic the historical data is pretty clear: both renting and owning a home can generate large sums of wealth in the long run. In the case of homeownership, that’s assuming you live there long enough to build equity and recoup the big, additional expenses that come with purchasing and maintaining it. And with renting, that’s assuming you invest wisely the extra money you would’ve otherwise spent buying and maintaining the home. A real estate investment firm recently crunched 50 years of data (see pages 3-5 for all of their assumptions) to see exactly how each hypothetical scenario fared. Wealth after 30 years *Data shown is for illustrative purposes only, and is not reflective of any Betterment portfolio or performance. As such, this graph does not reflect any of Betterment’s management fees, transaction costs or fund expenses. Renting slightly edges out buying in this study, although a buyer with a paid-off home could arguably close the gap in subsequent years if they invest their old mortgage payments. But these nitpicks miss the point, because in terms of wealth, both people are doing just fine in this hypothetical. So let’s all take a moment to exhale, because you can do well no matter which path you take. In the case of renting, it just requires you to actually invest those savings and not spend them. And we can help with that. How to realize the potential of “renting + investing” Let’s use the median house in America as an example. It costs roughly $415,000. Here’s a rough approximation of how much money you would need, both up front and ongoing, to buy and maintain it. Keep in mind the ongoing costs listed below exclude the mortgage payment itself. Up-front expenses Amount Downpayment (20%) $83,000 Closing costs (2%) $8,300 Agent commission* (3%) $12,450 Total $103,750 Ongoing expenses Property tax** $484 Homeowners insurance $179 Maintenance $534 Total $1,197/month Pay attention to your emotions here, because they can help guide your decision making. If you can’t imagine saving and investing this much money right now, then you may struggle to afford owning the median U.S. home. And that’s okay! One's answer to the Rent vs Buy question may very well change multiple times throughout life. Just remember you can still build wealth while renting. Crunch the numbers above based on your own budget, then follow two steps to see the strategy through to the end: Start saving for those upfront costs now. Once you have that amount in hand, start investing the equivalent of those monthly non-mortgage costs via recurring deposit. Now it’s no longer a hypothetical. You’re putting those savings to work. Should you decide to buy down the road, you’ll be more financially ready—and the tradeoff will be clear as day: Buy a house. Or keep saving at your current levels. There’s no wrong answer here. Whatever you decide will be the right decision for you. And it’ll be an informed one. -
When will interest rates finally start to fall?
When will interest rates finally start to fall? We look back at the last 40 years of interest rate peaks and plateaus for a guide. This decade of investing has come to be defined by one thing: interest rates. The federal funds rate has sat north of 5% for more than a year now, a level neither seen nor sustained since the runup to the Great Recession. Which has everyone from bond traders to homebuyers asking the same question: When will rates finally start to fall? Optimism that the Federal Reserve would cut rates throughout 2024 was widespread to begin the year, but inflation’s small uptick to start the year has thrown cold water on those expectations. So how far in the future could the first cut be? No one knows the exact answer, but history offers several reference points. Rate peaks are common, plateaus less so When you take a look at the past 40 years, the cyclical nature of short-term rates stands out: The economy heats up, the Fed raises rates. The economy cools down, the Fed lowers rates. Rinse and repeat. Historically-speaking, however, it’s usually only a matter of months until rates drop after peaking, which means our current cycle is starting to look more like a plateau by comparison. It’s already lasted longer than all but one other cycle since the 1980s. Rate peaks have lasted 8 months on average since the late 80s This holding pattern isn’t without reason, of course. Inflation has slowed considerably since 2022, but it’s been stuck in its own holding pattern as of late, hovering more than a full percentage point over the Fed’s stated target of 2%. On the flip side, supply and demand appear better balanced, so if inflation resumes its slowdown in the coming months, then signs point to possible rate cuts late in the year. So what’s a saver to do? Consider deploying excess dollars Whenever the federal funds rate falls, other interest rates follow, including variable interest rates on high-yield cash accounts. Stocks and bonds, on the other hand, tend to benefit from rate cuts. Because of this, we suggest taking another look at your cash situation. If you’ve been stockpiling cash above and beyond an emergency fund and other major purchases, it may be the time to start investing some of that excess in the coming months. Feeling anxious about diving into the market right now? Our all-bonds BlackRock Target Income portfolio offers the potential for higher yields than cash in exchange for taking on some risk. If or when a long-term goal comes to mind for those funds, consider switching to a diversified portfolio of stocks and bonds. And keep in mind you don’t have to move all your money at once. With a few clicks, you can set up a recurring internal transfer to slowly but steadily dollar-cost average your way from cash to investing.
Meet some of our Experts
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Corbin Blackwell is a CERTIFIED FINANCIAL PLANNER™ who works directly with Betterment customers to ...
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Dan Egan is the VP of Behavioral Finance & Investing at Betterment. He has spent his career using ...
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Mychal Campos is Head of Investing at Betterment. His two-plus decades of experience in ...
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Nick enjoys teaching others how to make sense of their complicated financial lives. Nick earned his ...
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