January 26, 2023

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TOGETHER WITH

Good day. U.S. GDP for Q4 '22 rose 2.9%, higher than expected, making it more challenging for economists to make their recession predictions. Can you guess how many recessions there have been in the U.S. since 1945? a. 3, b. 13, c. 23. Follow the wave 🌊 below for the answer.

The money topics for today are:

Target Date Funds: Pros & Cons
Should You Tap Your Retirement To Buy A Home?
What's a Mortgage Buydown?

INVESTING

Target Date Funds: Pros and Cons

A target date fund (TDF) is a mutual fund that holds a diversified mix of stocks, bonds, specialty funds, and cash and is optimized for the best risk-adjusted return for investors investing for their retirement.

Their fund name usually includes the year you plan to retire. So if you're 25 years old right now and looking to retire in 40 years, a target date fund of 2063 would be your best option.

These funds have the simple goal of adjusting their allocations, and therefore their risk/return profiles accordingly, as an investor's age changes, especially as they near retirement. That means, these funds will typically start out with a very high allocation to stocks that decreases over time, while bond/fixed-income allocations increase as you near retirement age.

Example: The Vanguard Target Retirement 2065 Fund (Ticker: VLXVX) currently has an equity to bond ratio of 88.75% to 9.77%, whereas the Vanguard Target Retirement 2020 Fund is sitting at 43.74% stocks and 55.07% bonds.

After reaching retirement, nothing unique happens to the fund. It simply coasts along its intended glide path, designed to safely take you through retirement.

The pros and cons

The pros: It's a set-and-forget strategy that keeps you invested with reasonably good returns on your retirement funds over years. They're easy, hands-off, and reliable.

The cons: With standardization and convenience comes a lack of customization, and the potential to miss out on some noteworthy returns if you're confident in your ability to craft your own retirement portfolio. Fees on TDFs also tend to be multiples higher than their index (or passive) fund counterparts, but managing a portfolio of index funds will require regular rebalancing.

The big picture

With a carefully crafted asset allocation glide path and simplicity comes safety and less work on your part, but this can also come at the cost of the added benefits a passive or a more growth-oriented fund or strategy might've yielded you otherwise. If this sounds like your cup of tea, know that TFD fees can range anywhere between 0.1% to more than 1.5%, so be sure to do your own research.

Take this related lesson on this topic and earn Dibs 🟡 while you're at it:

IRA Fast Facts

Retirement Planning

8 mins

FINANCIAL PLANNING

Should You Tap Your Retirement To Buy A Home?

Perhaps one of the most popular questions in the world of finance right now is "should I be looking to buy a house as rates have dropped?"

The cost of buying a home has ballooned massively and with rates sitting at their lowest level since September, some prospective home buyers sitting on the sidelines are wondering if they should jump in now. Other eager buyers are also exploring alternative financing options to pull off a purchase, maybe even tapping into their retirement savings.

Wait, you can do that?

Methods to do so

Your Roth IRA: If you're thinking of going this route, the best-case scenario is if you've got an existing Roth IRA with a healthy balance. With a Roth IRA, you can withdraw the contributions you've made into the account penalty-free at any time, and for any reason, as long as you've had the account opened for at least 5+ years. Why? Because it's money you've already paid taxes on. The additional nuance here is that first-time home buyers can also take out up to $10,000 of investment earnings penalty-free before they're 59.5 years old as long as the account is 5+ years old. The IRS considers a first-time home buyer someone who hasn't owned a home for the last two years.
A traditional IRA: If you withdraw money from your traditional IRA before age 59 1/2, you'll usually have to pay the 10% penalty on the withdrawn amount. A first-time home buyer can withdraw up to $10,000 from their IRA penalty-free. The $10K exemption is available for individuals, meaning married couples can withdraw $10K each for a total of $20K towards their first home.
401K options: What makes the 401k unique here is that instead of withdrawing, you can take out a loan against the balance up to $50k or 50% of the account, whichever is less, and pay the interest rate on the loan back to yourself. This isn't ideal, and loan periods tend to be short (less than 5 years) which can result in hefty payments. Withdrawals, on the other hand, are not afforded the same penalty or tax exemption luxuries that IRAs get, meaning any withdrawal made for a home purchase would be quickly eroded by those fees.

A sober look at using retirement to fund a home purchase

Using some of your future to finance a home purchase sounds risky, and without context, it is. However, there might be a few instances where this may be a reasonable route to take.

You're young: If you're in your 20s or 30s and looking to buy a home, it might not hurt to take some extra funds out of retirement to buy a home, especially if you've already been investing consistently. A home can be a good investment, and so it's likely you'll make that loss up in the value and appreciation a home provides.

You're avoiding private mortgage insurance (PMI): If you don't quite have enough of a down payment (20% of the loan) to avoid paying for private mortgage insurance, pulling out a little retirement money to get over that hump might be wise. PMI ranges from 0.5%-2% on average, and so dodging this could end up saving you thousands per year.

But in other cases, it may be better to think twice:

You're older: Depending on how much you've saved for retirement, pulling out some of those savings could jeopardize your ability to retire if it's getting late in the game. This is heavily situational though and depends a lot on the rest of your finances and living situation.

Your balance is low: If, for example, you've only saved $10,000 for retirement in your Roth IRA and you're considering pulling it all out for that first-time homebuyer exemption, you should also first consider the fact that you're depleting the entire account value, and weigh any other options before doing so.

Take this related lesson on this topic and earn Dibs 🟡 while you're at it:

Home Buying Power Tips

Housing

5 mins

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HOUSING

What's a Mortgage Buydown?

The median sale price of homes in the US is up over 40% in just the last 3 years. And despite the fact home prices may be cooling, buyers still face an exceedingly costly housing situation right now, and saving tips are more welcomed than ever.

While our hands are tied regarding the markets and their movements, there are still some extra steps we can take that could potentially save thousands over the life of a mortgage. Enter the mortgage buydown.

Mortgage buydowns — what to know

Buydown basics: A mortgage buydown is when a seller or homebuilder agrees to put up some cash towards the home sale and in exchange, the borrower receives a lower mortgage rate, usually dropping by about 1% to 3%.
Logistics: Buydowns are a concession made on the seller or builder's side because of their incentive to do business, and it often saves them money relative to what a price cut would cost. The cash goes to an escrow account and provides the lender with the funds necessary to lower the buyer's interest rate.
The benefits: Because buydowns are negotiated, there's flexibility in how they can be arranged. Although lifetime buydowns do exist, the most common structures are temporary buydowns of 1-3 years of lower rates for buyers. Buyers get savings via lower monthly mortgage payments in the first few years of their loan, as opposed to a simple sale price reduction which would have its benefits spread across all 30 years of the mortgage.
The downsides: Buydowns have their drawbacks as well. Although buyers do receive a lower interest rate, most often it's temporary, which could spell budgeting trouble when the rate resets. Also not all property types are eligible (i.e., investment properties and cash-out refinances don't qualify), and there are state and government-specific regs and requirements that may apply.
The takeaways: Buydowns can save money for buyers. Consult your prospective lender before you make a firm decision as restrictions may apply. And in a buyer's market, negotiating for a lower sale price most often will save you more money.

Take this related lesson on this topic and earn Dibs 🟡 while you're at it:

Mortgage Fundamentals

Housing

5 mins

🌊 BY THE WAY

📉 Answer: There have been 13 recessions since 1945, occurring about six years apart on average. Excluding the Great Depression, U.S. recessions have lasted an average of about 10 months (Hartford Funds)
📈 U.S. GDP rose 2.9% in the fourth quarter, more than expected even as recession fears loom (CNBC)
🎁 ICYMI. Ways to file your U.S. taxes for free (Finny)
🏙️ Goldman Sachs says 4 US cities will suffer a 2008 crash in home values (Fox Business)
💊 Amazon launches a $5 monthly subscription for unlimited prescription medications (The Verge)
🔎 Finny lesson of the day. With taxes coming due, let's review what's tax-deductible and what's not:

Tax Deductible or Not?

Taxes

8 mins

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Finny is a financial wellness platform for employees. The Gist is Finny's twice-a-week (Tues & Thurs) newsletter covering personal finance, market trends and investing insights. The content team: Austin Payne, Carla Olson. Finny does not offer investment and stock advice.

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