Oct 31, 2021
With increasing access to financial information and investment tools, more people are seeking ways to manage their money better and make smarter investment decisions. One topic that comes up quite often is mortgage repayment. There has been a growing debate on whether to pay off a mortgage early or invest the extra cash instead.
On the one hand you have an argument led by numbers, and on the other hand, you have a strong case for the peace of mind that comes with being mortgage free, which anyone in that camp will tell you is priceless. If you ask me, I think there’s no right or wrong decision here; or is there? The truth is either can be right or wrong, depending on your personal goals, circumstance and values. That’s why it’s called personal finance — because it’s personal.
What is more important than either option is making an informed decision, which includes knowing what could go wrong and having a mitigation plan.
If you consider investing, the numbers are quite compelling and you might wonder why everyone is not doing it. For instance, if you choose to pay an extra $500 off your 3% mortgage every month for 10 years, you’ll be shaving about $9,870 off your interest cost. But if you invest the same amount in the stock market at a return of 10%, after 10 years, your return will be $42,422. That’s more than 4 times your interest savings, and the numbers become even more staggering with time.
However, if you take a closer look, you’ll realise that the potential returns don’t tell the whole story. The investing argument is usually based on the important assumption that your investment will appreciate over time. Although, this is realistic, but it’s not guaranteed. Anything can happen. Think 2020 or the Japanese stock market that crashed and couldn’t recover for more than 30 years! The longest bear market in modern history. I believe the sentiment won’t be the same in this scenario.
The math is great, but to achieve its promised results, there are some factor beyond our control that have to be in our favour; not to mention the personal psychology and behavioural part of money management. We’re not all risk-averse; and certainly, not everyone can take risks and sleep well at night. That’s why neither of the two paths is for everyone.
In the end, choosing the right path, is only one part of the solution. For instance, if you’ve decided to invest, instead of paying off your mortgage early, there are two things you should avoid at all cost.
So, after all the debate and analyses, you decide not to pay off your mortgage early, so you can invest your extra cash, because of the compelling numbers. Good decision. However, for some reason, you choose not to commit to this plan. Maybe you succumb to the temptation of diverting this money to other things, like acquiring liabilities and keeping the rest in the bank. This is where the behavioural side of personal finance comes in.
Like I said earlier, it was never just about the math, certain money habits, consistency and self-discipline are required to achieve success in this area. Now, the purpose of making your money work harder for you has been defeated. As a result of your action, or inaction:
The key here is understanding that having a great plan and not executing it, is as good as having no plan at all. If this sounds like something you might do, don’t despair, you can always improve your money habits to follow through on your financial goals.
Choosing to invest your extra cash instead of paying off your mortgage early, comes with an element of risk; irrespective of the type of investment you choose. Returns are not guaranteed, like the interest savings you’ll make from paying off your mortgage early, or any other loan for that matter.
Nonetheless, one thing you shouldn’t do, is invest your hard earned money in something you don’t understand. With the earlier decision of splashing the cash, you may take consolation from some fond memories you had. Here, you can lose it all, and have nothing to show for your smart decision to invest. That promising penny stock may crash and never recover, your business can fail and the buy to rent property may not give you the return it promised on paper.
If you lose your extra cash due to bad investment decisions; just like above, there are consequences. That’s why you should research your investment options thoroughly, so you don’t lose money.
This might involve taking a deep dive into the company you’re investing in; validating your idea, should you want to start a business or learn to become a seasoned real estate investor. If doing this sounds like a lot of work, you can consider investing in an index fund, like the S&P 500.
The point is, knowing you can make more money by investing, instead of paying off a loan early, is not enough; you still have to determine the best investment for your unique circumstance.
As you can see, it doesn’t matter whether you choose to invest your extra cash or pay off your mortgage early. What is perhaps, more important, is choosing the better option for your unique situation, while considering what is most important to you.
However, if you’ve decided to invest instead of paying off your mortgage early, make sure you:
Finally, irrespective of what your financial goals are, to realise them, you need to craft a plan and follow it to the letter. Remember, having a great plan and not executing it, is as good as having no plan at all.
This article is for educational and informational purposes only and should NOT be considered a financial advice. Investing is risky. Please seek the services of a licensed financial advisor should you require one.
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Segun Ojediran, MSc