Should you pay off your mortgage faster or invest your money?

Deciding whether to pay off your mortgage faster or invest is a common dilemma.

Paying down your mortgage (or utilizing an offset or redraw facility) gives you a return that equals your mortgage interest rate, and it comes with no risk of losing capital. This is especially true if it’s with an ADI and falls under the $250,000 government guarantee.

On the other hand, investing in shares generally offers a higher expected return compared to the mortgage interest rate. Historically, stocks have provided returns of around 10%, but this isn’t guaranteed. A higher expected return also brings higher risk, leading to a broader range of potential outcomes. Your actual return could vary significantly from what’s expected.

Some people highlight that the return from paying down your mortgage (or using an offset or redraw) is tax-free because it comes from reducing expenses rather than receiving income. So, it should be grossed up when compared to investing. However, with debt recycling, investing can share this tax-free benefit and even offer more advantages.

The decision between paying off the mortgage faster or investing is quite similar to borrowing to invest. This strategy can be a good fit if you have:

• Sufficient equity to borrow against
• A high marginal tax rate
• Extra cash flow or a buffer to manage interest payments
• A long time horizon
• A high risk tolerance

With regards to paying down excess funds into your mortgage vs investing:

• Having Equity is not an issue.
• Having a higher marginal tax rate is less of an issue (but still relevant) at mortgage interest rates.
• Having additional cash flow is less of an issue since the question is about additional payments on top of your regular mortgage payments. If you can afford your current repayments, this probably isn’t a significant issue.

The last two items are what needs focusing on – a long time horizon and a high risk tolerance. Both of these relate to the fact that investing to achieve a higher return than the interest cost means investing in growth assets. Since growth assets are volatile by nature, you need a long enough time horizon and a high enough tolerance to see your investment’s value fall significantly in the short and medium-term without selling.

Ultimately, the decision to pay off your mortgage faster versus investing hinges on your risk tolerance.

You have a higher risk tolerance when you:

• Don’t have short-term needs for your capital, maintain an emergency fund, have secure income, and carry life insurance.
• Are younger and further from retirement or financial independence.
• Feel comfortable with debt.

A higher risk tolerance enables you to invest more aggressively, offering the potential for a higher expected return. This return is more likely to materialize the longer you leave your investment untouched.

Conversely, if you’re uncomfortable with debt (as many people are), worried about job security, especially with dependents, or concerned about being tied to your job to pay down debt, it’s perfectly reasonable to prioritize paying extra on your mortgage. While the long-term expected return from investing might be higher, the actual return of paying down the loan is certain.

In summary, your risk tolerance will dictate whether to allocate your additional capital towards safe or risky investments (like your mortgage).

Safe investments are ideal when you have:

• Short-term needs for your money.
• A lower appetite for risk (including debt).
• Little or no need to generate higher returns, such as when nearing retirement or financial independence.

Risky investments are better suited when you have:

• No immediate need for the capital (typically a 10+ year time horizon).
• An appetite for higher risk.
• A need for a higher return.

Whatever your choice, avoid rotating back and forth based on fluctuating interest rates on your home loan. Rotating back and forth is the quickest way to erode your returns. Instead, pick a strategy and stick to your plan.

And remember, you don’t have to choose between the two. You can hedge your bets by investing part of your capital in shares and putting the rest into an offset account to reduce your mortgage. It’s not necessarily an either/or decision.

If you do decide to invest:

1. Maintain a solid cash buffer in an offset as your emergency fund.
2. Consider debt-recycling the amount you plan to use for investing.