One of the most common questions we hear from our clients is whether they should focus on paying down their mortgage or invest their extra funds elsewhere. It’s a crucial decision that can significantly impact your long-term financial wellbeing, and your investment style should align with your financial goals and risk tolerance.
Understanding Your Financial Goals
Understanding your financial goals is a crucial step in your investment journey. Your goals will guide your investment decisions and help you stay focused on what you want to achieve. Consider both short-term and long-term goals, as they will affect your investment strategy. Your objectives depend on your life stage and ambitions. Younger investors tend to focus more on growth investments and long-term wealth accumulation, while those closer to retirement typically prefer generating income and capital preservation.
When setting your financial goals, consider the following:
- What do you want to achieve through investing?
- How much money do you need to achieve your goals?
- What is your time frame for achieving your goals?
- What is your risk tolerance?
By understanding your financial goals, you can create a tailored investment plan that aligns with your needs and objectives. This clarity will help you navigate the complexities of the stock market and other asset classes, ensuring your investment decisions are well-informed and aligned with your financial aspirations.
The Appeal of Mortgage Reduction
There’s an undeniable psychological comfort in building equity in your home. Each extra payment brings you closer to outright ownership, providing a sense of security that’s hard to match. Moreover, reducing your mortgage comes with several clear advantages:
- It’s a risk-free investment strategy
- The interest savings are tax-free
- It’s easier to commit to regular extra payments
- You’re building equity in a tangible asset
The Case for Investing in the Stock Market
However, in today’s low-interest-rate environment, there’s a compelling argument for investing beyond your home. Here’s why:
Superannuation Benefits
Contributing extra to your superannuation can be particularly advantageous. With a concessional tax rate of just 15% on earnings within super, you’re potentially keeping more of your investment returns compared to paying them at your marginal tax rate.
Tax Advantages
You can contribute up to $27,500 annually to super and potentially claim a tax deduction, or up to $110,000 using after-tax income. Understanding the tax implications of these contributions can significantly reduce your overall tax burden while building your retirement nest egg.
Portfolio Diversification
Investing outside your home allows you to spread risk across different asset classes:
- Fixed interest investments
- Commercial property
- Domestic shares
- International shares
Running the Numbers
Let’s look at a practical example:
Imagine a $500,000 home loan over 30 years at 5% interest:
- Standard monthly repayments: $2,684
- Total interest over the loan term: $466,279
While investing in shares can potentially yield higher returns, keeping money in a bank account provides a safer option, though it may result in lower returns compared to the stock market.
Scenario 1: Extra Mortgage Payments
If you pay an additional $500 monthly:
- Loan term reduces to 21 years and 4 months
- Total interest paid: $313,398
- Interest savings: $152,881
Scenario 2: Investment Strategy
If you invest that same $500 monthly at 7.5% return:
- After 30 years: $678,433
- Net benefit: $525,552 more than the interest savings, even considering the risks when share price falls.
Finding Your Balance and Risk Tolerance
While the numbers might suggest investing is the better option, this assumes:
- Consistent 7.5% returns after tax
- Ability to maintain the investment strategy for 30 years
- Comfort with investment risk
For most people, the optimal approach is a balanced strategy combining:
- Early mortgage repayment
- Additional super contributions
- Building a diverse investment portfolio
Seeking Professional Advice
Seeking professional advice is an essential step in your investment journey. A financial advisor can help you set your financial goals, understand your risk tolerance, and create a tailored investment plan that aligns with your needs and objectives.
When seeking professional advice, consider the following:
- Look for a qualified advisor: Ensure your advisor has the necessary qualifications and experience. Check their credentials and ask for references.
- Understand their fees: Know how your advisor is paid and what services they offer. Transparency in fees will help you avoid unexpected costs.
- Ask questions: Don’t be afraid to ask questions about your investment plan and the advice you receive. A good advisor will be happy to explain their recommendations.
- Monitor your progress: Regularly review your investment plan with your advisor to ensure you’re on track to achieving your goals. Adjustments may be needed as your financial situation or goals change.
By seeking professional advice, you can gain a deeper understanding of investing and make informed decisions that align with your financial goals. This guidance can be invaluable, especially when navigating complex financial markets and making significant investment decisions.
Avoiding Common Mistakes
Investing can be complex, and it’s easy to make mistakes. Avoiding common mistakes can help you achieve your financial goals and avoid costly errors.
When avoiding common mistakes, consider the following:
- Don’t put all your eggs in one basket: Diversify your portfolio to reduce risk. Spreading your investments across different asset classes can help protect your capital.
- Don’t try to time the market: Invest for the long-term, rather than trying to time the market. Market timing can be risky and often leads to missed opportunities.
- Don’t ignore fees: Understand the fees associated with your investments and try to minimise them. High fees can erode your returns over time.
- Don’t be emotional: Make informed investment decisions based on your financial goals and risk tolerance, rather than emotions. Emotional decisions can lead to poor investment choices, especially during market volatility.
By avoiding common mistakes, you can create a tailored investment plan that aligns with your needs and objectives. This disciplined approach will help you stay focused on your financial goals and navigate the complexities of the stock market and other investment opportunities.
Next Steps: Seek Professional Advice
Every financial situation is unique, and what works for one person might not work for another. That’s why we recommend speaking with a financial planner who can help you:
- Assess your current financial position
- Understand your risk tolerance
- Design a strategy that aligns with your goals
- Regular review and adjustment of your plan
Ready to create your personalised financial strategy? Contact our team today for a consultation.