Building Wealth And Being Happy: A Practical Guide To Financial Independence by Graeme Falco

Author:Graeme Falco [Falco, Graeme]
Language: eng
Format: epub, azw3
Published: 2016-11-27T23:00:00+00:00

Should I pay off my mortgage or buy investments?

Let’s say after all your bills are paid for the month, you’re left with some extra cash. Should you use it to pay off your mortgage, leaving you debt free earlier? Or should you buy some low-fee exchange traded funds (ETFs)? The answer is not always straightforward, with each option having both pros and cons, and it depends largely on your personal risk tolerance.

Paying down your mortgage means that you’ll save on interest costs in the future. Think of this as a guaranteed return on investment. Wow, a guaranteed return! That sounds like a pretty good deal and it is good. But the alternative, investing in equities, could provide even greater returns. If you have a recent mortgage, it is likely at a less than 4% interest rate. Compared to historical equity returns, your mortgage might actually be giving you a pretty paltry return. Of course, that is just in the long run. If your risk tolerance can stomach short-term losses, then consider buying the equities.

Now, the above doesn’t mean that you should avoid paying off your mortgage or other debt in favour of buying investments. Debt is a funny thing and people often feel constrained by it even if they have the means to pay it off but choose not to. If having debt keeps you up at night, then why subject yourself to that stress? It may not make pure financial sense but there’s a point where your personal well-being might trump your spreadsheets and formulas.

Sometimes it can be helpful to push logic to extreme scenarios to see if it still holds up. Let’s say you owe a million dollars on your mortgage and tomorrow you win the lottery for a million dollars. Congratulations! You should put it all into investments, in order to maximize your returns, right? Well, what would you do if the situation was reversed? Imagine you owned a paid off house worth a million dollars. Would you borrow a million dollars against your home in order to invest in the stock market?

For most people, the answer is likely no. Even though logically and mathematically the two scenarios are equivalent, the psychological comfort of that guaranteed return can’t be overstated. Very few investments have no variance, and that fact has an added emotional value to the pay-off scenario when compared to the various outcomes possible with other investments. There’s no easy answer here. But when you figure out what percentage of those million dollars you would be willing to put into your investment accounts, then you’ve found your risk tolerance.

Let’s put this another way: taking out a mortgage instead of buying a house with cash means that your net worth will likely be higher at the end of the mortgage. That’s because your investment portfolio will provide higher returns than the house over that time period. However, this approach will also lead to a lower portfolio success rate. You’ll be slightly more likely to run out of money because your annual expenses will be higher with a mortgage than with a cash purchase.

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