Planning for Big Purchases: Saving or Investing?
Sometimes in life, we need to make a big purchase.
The $50,000 wedding you only budgeted $25,000 for (oops). A 40-ft. aquarium to keep your cat busy during the day. A house with a backyard so it’ll distract your kid while you Zoom within an inch of your life. Oh, and four words: SoulCycle at Home Bike (oops again).
What considerations should we think about when planning for big purchases?
Today, we’ll look at this from two angles:
Saving up for big purchases, and the optimal way to do so (read: should you be saving in a savings account or investing the money?)
Using the money you’ve saved or invested for a purchase
Timelines for saving up for big purchases: Saving vs. investing
I hear people ask fairly frequently: “I want to buy a house in X years. Should I invest that money?”
Then I ask: “Well, is your timeline flexible?”
If you’re signing a blood oath with your lender in seven months and you need that down payment ready to rock—or else—it’s probably not wise to put it in the stock market and risk losing some of it, like many of us are experiencing in this bear market.
But if you’re like, “Meh, I wanna buy a house…eventually…probably in like, three to five years. But who’s counting? I don’t know,” then I wouldn’t let that down payment wither away in a savings account (even a “high-yield” one, if you consider .5% a high yield).
Suggestion #1: If you need the money in 12-18 months and your timeline is not flexible, don’t bother with investing. Just save it instead.
Aside from the risk of losing money you’ll need, the bigger issue with this approach is the fact that investing for a few months won’t really do much. Sure, you may make a few hundred bucks, but really, investing is a long-term game. It’s not intended to be something you do for a few months then call it a day.
Investing builds wealth over years of compounding. If you don’t have years (and you’re not willing to wait), just keep it in cash.
Now, if I were Ruler of the Universe, everyone would invest in their twenties before doing anything major like buying a house—everyone would have a few hundred thousand by the time they needed to make this decision, so it wouldn’t be an issue. But since I realize that’s not always how people operate, I think it’s important to state a timeline explicitly here.
That said, if you’re still in the process of building something as big as a down payment (meaning you don’t have the full amount yet) and you do have a few years ahead of you, investing can supercharge that experience. (And while I have your attention about housing, this post helps you determine whether you’re better off renting or buying.)
“If you’ve got several years to accumulate the funds, investing in something flexible (like a brokerage account) probably makes sense.”
Maybe you don’t want a down payment—maybe you want a Soul bike (again, guilty) or a $4,000 pure-bred doodle shmoodle dog from a breeder named Anastasia (though, may I humbly suggest adopt a shelter animal like Sam Cat?). These purchases aren’t worth tens of thousands of dollars, yet they still need to be budgeted for separately from regular spending—and if you’ve got several years to accumulate the funds, investing in something flexible (like a brokerage account) probably makes sense.
“But Katie, what about the taxes in a brokerage account? Shouldn’t I avoid taxes by just saving my money instead?”
I understand the fear around paying capital gains taxes, but hear me out: The interest you earn in a high-yield savings account is also taxable. In fact, it’s taxed at a higher rate than long-term capital gains and the same rate as short-term capital gains.
That means if you’re afraid to invest for something that’s still a couple years away for fear of paying long-term capital gains taxes on the gains, you should also avoid high-yield savings accounts—because you have to pay tax on that growth, too.
That’s why your HYSA provider sends you a 1099-INT for tax season. The interest is taxed like ordinary income, meaning it’s taxed at your marginal tax rate.
Check out this Instagram post where I broke this down with an example that demonstrates why the HYSA may be costing you more than you think if you’ve got a flexible timeline of more than a couple years.
TL;DR: Taxes should be the least of your worries when it comes to make the saving vs. investing decision. At the end of the day, if you’re paying capital gains taxes on your earnings (usually 15%), it means you made money.
The most important thing is time horizon.
Suggestion #2: If you’re saving up for a discretionary purchase that costs less than $10,000 but more than what your monthly budget allows for, designate a few categories in your budget that can be put “toward” that saving goal each month.
Here’s the thing: When saving up for my bike, the thing that I tried to avoid was dipping into money that I would have otherwise been saving and investing to pay for it. Instead, I wanted to defer existing spending into the future where possible.
Another high-level example:
Let’s say I spend $3,000 per month and invest $2,000 (so my total income = $5,000). If I’m saving up for my [insert expensive thing here], I’d ideally be shaving some money off that $3,000 spending chunk each month vs. dipping into the $2,000 per month I’m investing.
“The bulk of the savings for the discretionary item should ideally come from money you were planning to spend anyway. ”
Maybe I have $300 earmarked for travel and $300 earmarked for shopping. I’d try to file that $600 chunk that would’ve been spent in those two categories for my future expense and not spend it, waiting for the $600 chunks each month to accrue to the point that it’s enough for [thing I’m trying to buy] while still meeting the same investing goal every month.
Remember, money is about priorities. You can buy expensive stuff and still meet your investing goals—you simply have to plan for it. And maybe you’re not earning quite enough yet to where you can defer the entire amount from present-day spending, but the bulk of the savings for the discretionary item should ideally come from money you were planning to spend anyway.
Too often, the chunk of money we’ve earmarked to invest is the first place we go when we need cash. Instead of investing it, we set it aside and blow it on something called a Cloud Couch from Restoration Hardware (which I’ve been told is all the rage with the Zillennial YouTubers), investing goals be damned.
It pains me so: The power of compounding is on your side to grow that investing chunk to Cloud Couch-levels over time instead of spending now.
Using your savings: An order of operations for spending
Maybe you’ve got plenty of money lying around and you’re ready to make a big purchase. The good news is, if you’ve followed the first two suggestions in the “save up” period, this shouldn’t really be a question: You’ve likely got the cash (or investments) earmarked somewhere already.
But let’s say you’ve found this post on the other side of saving. You’ve saved in an emergency fund. You’ve saved in a brokerage account. You’ve got a Roth IRA. You’ve got funds to draw from everywhere. Where do you pull from to make your big purchase?
Here’s how I think about this decision, based on the “value” of the money in each of these accounts from worst to best:
The worst place to pull from: Your Roth IRA
While your Roth IRA can technically function as a back-up emergency fund because you can access your contributions at any time, I wouldn’t recommend it. Your Roth dollars are the most valuable ones you have because they’ll never be taxed again. They’re a veritable wealth snowball, and you don’t want to do anything that’ll make that snowball smaller unless you absolutely have to. If you do pull out (your limited!) Roth contributions, you can’t retroactively go back in and re-contribute those same funds for the original contribution year (if I put in $6,000 in 2020 and took it out in 2021, I can’t then go back and put $6,000 of 2020’s contributions back in because 2020 is already over).
The second-worst place to pull from: Your Emergency Fund
While needing an at-home stationary bike that connects you to a portal of beautiful, sweaty people can often feel like the closest thing to an emergency you’ve experienced since the Kardashians announced their new show on Hulu, it’s something we should plan to buy, not buy in a frantic haze. The emergency fund is the backbone of your financial life, because it’s what enables you to invest comfortably. Without a fully stocked emergency fund (read: a cushion of cash you could pull from if shit hits the fan), you expose yourself to unnecessary risk. The amount you need in your emergency fund definitely varies depending on your lifestyle, but in general, I wouldn’t recommend using this for a purchase you can plan for.
The worst thing you can do, in terms of opening yourself up to a lot of financial risk, is use your entire savings to put a down payment toward a house. When you buy a home, you’re also kinda buying a headache. Shit breaks, and it costs money. Buying a home is a situation that necessitates an emergency fund—if you have to use yours to get a house, it’s not yet time for home ownership.
The slightly fine place to pull from: Your taxable brokerage account
Notice how I said slightly fine. I’m not outright condoning dipping into your taxable brokerage account, but if you gotta pull from somewhere, it’s a good option. Because the dividend income and bond yield in this account is being taxed every year and you’ll be taxed on your gains when you eventually sell, it’s less valuable than the money in a Roth IRA. It’s also not as serious a line of defense as your emergency fund is. If money is in your taxable brokerage account, that money is usually excess.
After all, someone that invests aggressively for years will probably amass a pretty big sum in their brokerage account and may not keep much in cash. If you’ve got $150,000 in a brokerage account and you want to pull $1,000 out to buy a MacBook, have at it. What I’m trying to dissuade is someone who just started investing and has $3,000 in a brokerage account from pulling out $2,500 to buy a used Peloton on the black market (at least get a Soul bike!). Just kidding.
The technically optimal place to pull from: Your actual checking or savings account
If you’re like, “Thanks, Captain Obvious. WTF?” Hear me out: Cash is your least valuable asset. It’s a melting ice cube, losing money to inflation every year. This is why Suggestion #2 above (planning intentionally for your purchases) matters so much. It allows you to shuffle a few hundred bucks every month into a nearby cash account that you can use without having to sell any assets in a brokerage account (or, worse, the Roth IRA).
This is where we tie everything into a nice little bow and circle back to our original “saving up” piece. Ideally, you’d use money that’s “leftover” in checking from spending every month. What happens when you under-spend for a few months in a row? You ultimately end up with a nice little pool of extra cash from your cash flow just hanging out, unspent. That sum is the ideal chunk to spend on whatever it is you’ve got your eye on. You aren’t disadvantaging your investing goals, you’re not putting yourself in a dicey position with your emergency fund, and ultimately, it’s money that would’ve or should’ve been spent anyway.
I realize this likely won’t work for something as big as a down payment. You don’t just accidentally underspend enough to buy a house; that’s an act of intentional wealth accumulation. Here’s how I personally think about it: I put thousands of dollars every month into a brokerage account. Whether I use that brokerage account as a source of income in early retirement or use some of the money later to buy a house is irrelevant at this point: What’s important is that the money is building wealth more quickly than if it were just chillin’ in a savings account.
With my panini bike purchase, I had been consistently several hundred dollars under-budget for the previous six months or so. I know this was the case because I track my income, spending, and investing every month, so I could see the portion allocated for spending, and I knew it was hanging out in checking, waiting to be spent. I didn’t know I was going to end up spending that money on a bike, but I knew at some point something would come along.
Being able to get that bike was the product of months (if not years) of making decent financial decisions most of the time. It didn’t require perfection, just attention (and tracking. Lots of tracking.).
Conclusions
I reiterate: Your saving and investing plan doesn’t have to be perfect!
But it’s the difference between having some semblance of a plan and tripping through your life with an AMEX Platinum in your outstretched hand, swiping indiscriminately.
Every layer of this whole “financial wellness” game layers on top of each other. First comes the budget. Then comes the different types of accounts. Then comes an article like this one, that builds on those two fundamentals as a way of determining the most optimal way to live a real life within the parameters of the financial structure you’ve created for yourself.
Other resources for developing a good plan
For more free beginner content about taking some of these first steps, check this out.
For the Wealth Planner, my ~ signature ~ planning tool (and the one that I use), check this out.
