I had a meeting with an investment advisor a few weeks ago, and he suggested I put money for a home-buying fund into a municipal bond mutual fund. I don't see the point... Interest rates suck right now, so yields are low. At the same time, if they go up, I'll probably end up losing money, because the value of my bonds will decrease.

Am I making sense here? I feel like I'm probably better off just keeping the money in cash (time horizon for buying a house is about 4-5 years).

Thoughts?

You might be better off keeping the money in cash.

Munis have had a great run recently. This is partly because interest rates in general have come down and partly because the quality that investors place on muni bonds has improved as city, county, and state budgets improve. I would expect the second factor to continue to improve.

The first factor is largely predictable. A bond fund will publish a "duration." While this has a technical definition, it is approximately the amount the price of the bond fund will fall for every 1% increase in rates. A fund with a 5 year duration will lose 5% of its value if rates go up by 1%. Given the fragile state of the economy and the Feds commitment to keep rates low for at least 2 more years, your principal risk is small.

You also get muni interest federal tax free.

I'm not trying to talk you into it but I also don't think you got bad advice, as long as the advisor was recommending something with low fees and a short duration.

Thanks for your answer DoingHomework.

For the longest time I have been trying to find a reasonable place to store cash in anticipation of buying a house. I just can't find a reasonable investment. I'm halfway considering just putting everything I've got into my Roth and taking principal withdrawals when the time comes to buy. I don't see the market going down. I see the market improving, and I see interest rates following. I feel like having my cash liquid will allow me to avoid a reduction in principal, while also giving me the flexibility to put it into a good savings account or bonds when rates go up again (which I think they will).

I read somewhere that you should pick a risk level that allows you to sleep at night. I don't feel like Muni bonds are risk-free enough in this case. I'm going to sit on cash for now, hope that inflation doesn't go too crazy in the meantime.

One more thought... what about REIT's? If real estate prices go up, and my savings are in REIT's, won't I be hedged against that sort of event?

Being able to sleep at night is very important! If you would worry about your muni investment then it is not for you. But it is realistic to expect munis to yield about 4% tax free over the next few years. That means you'll likely collect enough interest to offset any price decline.

I don't own any munis. But that is partly because I believe they should, over the long term, yield the same as similar quality bonds after accounting for a tax rate of about 30-35%, the highest federal bracket. Since I'm in a lower bracket they would have a lower equivalent yield for me than corporates. That's just my theory though. This country is on a tax-reducing binge as well. While that is good for me personally, it is not good for government budgets. So basically, I would not criticize your decision!

But be careful with REITS. They are an imperfect hedge for what you want to do since there is no REIT (by necessity) fr owner-occupied residential property equity. The residential REITS you will find are for mortgages or for apartment buildings ad rental properties. While these may or may not be good investments, they will not have the hedging properties you are looking for.

Right now I have about 3k set aside in cash and 3k in assorted stocks. This is seed money for my house fund. I don't really want to keep the 3k in cash, but considering the uncertainty behind bonds for the time being, I feel like it's the most reasonable choice.

Depending on your time horizon, a market-rate CD from Wells Fargo is something I've thought about. You have to deal with 3 years of non-liquidity, but the upside is pretty attractive and the downside largely nonexistent.