NEST EGG: Should you use extra cash to pay down your mortgage or invest in the stock market?
Having cash in your bank account will erode your purchasing power over time. Should you instead use this money to pay down your mortgage or invest it? The answer to this question depends on your situation. Since no investment solution makes equal sense to all individuals, it is essential to make informed decisions to reach your financial goals. Everyone has a different journey. Here are some general guidelines to help you assess your situation:
· Age and ability to take investment risk are inversely related. The younger you are, the higher your ability to take risk, and vice versa.
· Time horizon and ability to take risk are directly related. The longer the time horizon you have, the higher is your ability to take risk, and vice versa. A longer time horizon increases the likelihood of recouping any losses you might encounter along your investment journey.
· The keyword is “ability” to take risk. Other aspects of your life also influence your ability, e.g., job, family situation and short-term cash dependence.
· Another keyword is “willingness” to take risk, which relates to, e.g., saving goals, motivation, and preference for risk. But first, getting rid of any high-interest debt is recommended. If you can then clear that car loan & credit card debt. Establishing an emergency fund is also recommended. Typically having at least three months’ net salary as an emergency fund is prudent. With that out of the way, let’s have a closer look at two common alternatives if you have excess cash; pay down your mortgage or invest in the stock market.
Suppose you have a low ability or low willingness to take risk. In that case, accelerated mortgage repayments can be a good choice. Reducing the interest-bearing debt increases the likelihood that you can service the debt payments if interest rates rise or if you are the type of person who sleeps better at night with less debt. An extra mortgage repayment today will also increase your future disposable income. Additionally, owning a home is often more than an investment because it is an integral part of people’s lives.Paying down your mortgage and increasing your home “ownership” can provide a sense of security and satisfaction that can surpass any rational economic argument for investing elsewhere.
If you can earn an expected after-tax return in the stock market that exceeds your mortgage rate, investing in the stock market can be a viable alternative, assuming you have the appropriate ability and willingness to take risk. While stock market investing is not risk-free, it usually yields an expected return well above mortgage rates in the long run.
Using extra cash to pay down your mortgage or invest in the stock market comes with its pros and cons. Paying down your mortgage can protect against rising interest rates, reduce any psychological debt burden, and increase your disposable income in the future.
One potential drawback of accelerated repayments is the potential opportunity costs associated with foregone investment alternatives. Keep in mind that no investment solution makes equal sense to all individuals.
What is ideal for you might be quite different from what is suitable for your friends, neighbours, or colleagues.
Filter out the noise (e.g. their Bitcoin success stories!), focus on your situation, and make informed decisions so you can reach your financial goals.
For more information or a consultation contact Conor at www.tarafinancial.ie