A health savings account (HSA) is a tax-exempt account that an individual can set up to pay for certain medical expenses. The account is set up with a custodian and usually consists of two parts: a safe money market, or savings, portion, and an investment portion that may include several stock and bond mutual funds.
Annual Medical Expenses
The primary purpose of an HSA is to pay for medical expenses with pretax dollars. Estimate how much you are likely to spend in the next 12 to 24 months and keep that money in the safe (money market) part of the account. The rest can be invested.
Review the investment choices that your account offers. Check the mutual funds' three- and five-year performance and compare it to other funds in the same categories to identify the best investment vehicles.
Consider your overall financial plan and asset allocation. Your HSA investment portion should be part of it. You need to consider two things: (a) the best investment returns you can get and (b) the relative safety of your HSA investment. On the one hand, you don't want to invest in a laggard fund; on the other hand, you don't know when you might need the money. Even a fund with a good investment record may temporarily decline due to various factors just when you need the money, so you may end up selling at a loss. Since the HSA is funded with pretax money, you won't even be able to deduct the loss on your tax return.
Generally, a broadly diversified growth and income fund should be your first choice. A growth stock fund carries more risk. A bond fund has a lower return, and since bonds decline when interest rates rise, your bond fund may decline for several years in a row if interest rates start rising. A growth and income fund typically spreads its assets across stocks and bonds, so it is more stable and fluctuates less while providing a reasonable return over the long haul. Any dividends that the fund pays will be tax-sheltered.
HSA expenses --- custodial fees, expense reimbursement charges and other transaction fees --- can vary substantially from custodian to custodian. If your HSA balance is relatively low, these expenses can eat into the return regardless of how you invest, so your primary consideration may be to find an HSA account with the lowest expenses before considering investment options.
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