PAY OFF THE MORTGAGE, OR INVEST?
Should I pay off the mortgage faster, or use any spare money to invest? That’s a question I get a lot.
According to the textbook, the best approach is to pay off the mortgage as quickly as you can, before worrying about starting on your investing journey.
The floating mortgage rate is about 4.4 per cent at the moment, so if you make additional payments on your mortgage, that’s essentially the annual return you’re getting on that money.
Your other options for putting those funds to work will give you a varying range of returns. Term deposits are a very low risk option at around 1-2 per cent, depending on the timeframe, while managed funds, property and shares will deliver much more than this, albeit with a higher risk profile.
As an example, New Zealand shares have delivered an annual return of 10.6 per cent over the past 20 years, although this hasn’t always been plain sailing.
The market has had numerous ups and downs along the way, including a couple of big declines. The most notable ones are the GFC, when the NZX 50 index fell 44.2 per cent, and then last year in the wake of the COVID-19 pandemic, when it declined 29.6 percent.
As it always does, the market has recovered from these periods and moved on to new highs, but they have been highly disconcerting at the time.
In contrast, the “return” one gets from paying down their mortgage is risk free. Whether you’re paying the floating rate of 4.4 per cent, or something higher or lower, you’re guaranteed to have saved yourself that interest.
That’s why paying down the mortgage wins every time, when you’re basing it purely on the numbers. There’s nowhere you’ll find a similar return with zero risk, and without any tax to pay on that return.
When interest rates are higher, the argument strengthens further.
Here’s where I’ll deviate from the textbook and suggest that doing a bit of investing on the side can be a very good choice for many people.
While it’s hard to argue with the risk-free return of paying off your mortgage, the knowledge to be gained by educating yourself about money, shares and financial markets can be invaluable.
Financial literacy is an area where New Zealanders could do better, particularly when it comes to understanding our investing options outside of housing.
When you have some skin in the game, you often take a much greater interest in something.
Having a few investment interests, even small ones, might give you the motivation to start following companies, reading annual reports, and understanding how dividends work.
Like a lot of things in personal finance, as in life, it’s not black or white and there’s not necessarily a right or wrong.
Paying down the mortgage as aggressively as you can is a very sensible move, and it’ll get you on the path to financial freedom much faster.
However, using some of that disposable income to invest along the way is also going to pay off. If you follow a few simple rules you should do well in the long-term, even if you experience a bit of volatility at times (which is also a good lesson).
While you’re unlikely to find a better risk and return trade-off than making additional mortgage payments, you’ll learn a lot and put yourself in good stead to make better decisions when you do have more investable funds.