Ah the great debate: investing versus paying off the home loan. Many a family has struggled with this age-old question, and put simply, there is no real easy answer. But if we look at the pros and cons of investing, it might shed some light on your current financial situation and you can decide what option is best for you.
Debt versus investing
As everyone (hopefully) knows, a mortgage is an interest-bearing loan issued by a credit union or bank like Commonwealth Bank of Australia (ASX: CBA). Interest rates are at record lows currently, which means that a mortgage has never been cheaper or easier to service (although for the same reasons, property prices have been raising the roof over the last few years).
Unlike an investment loan, the interest on your mortgage is not tax deductible in Australia (although interestingly, in the United States this is not the case). Conventional financial wisdom normally dictates that paying off non-deductible interest should be your first priority and therefore you should direct any surplus cash into your mortgage before you start investing.
So you should just do that, right?
By making extra repayments on a 4.5% mortgage, you are netting yourself a 4.5% return on your money – not a bad thing, right? After factoring in a 2% inflation rate, this becomes 2.5% (remember, inflation eats away at the value of a debt over time). Historically, a dirt-cheap market-tracking exchange-traded fund (or ETF) can return you a much higher return on investment.
Take the Vanguard Australian Shares ETF (ASX: VAS), which has returned 10.44% per year to investors over the past 3 years (which is still 8.44% after inflation). Of course, ETFs like this can be volatile and some years you are likely to lose money. But over the long term, you can probably expect a similar level of returns in the 7–10% range.
Instead of maxing out your mortgage repayments, you could put a little of this on the side and make small investments into an ETF every few months, while still paying down the mortgage. This money will compound at a much higher rate and leave you with a sizeable nest egg once the mortgage is eventually paid off.
This strategy isn't for everyone and if you just want to get the banker off your back ASAP, then by all means, go nuts. But it pays to at least consider your options and decide which strategy is best for you and your family.
