Investor know thyself
15 April, 2016
It's a conundrum for many people — they want to pay their mortgage off but also want to start building an investment portfolio.
I have spent years encouraging clients to do both.
In some circumstances, a mortgage should obviously be repaid before investments are contemplated — but, for most people, by the time their mortgage is repaid, their investments won't have enough time to grow as much as they should.
When mortgage rates are very high, it's hard to argue a mortgage-holder should chase potentially higher returns elsewhere. If you are particularly indebted, it is clearly sensible to pay down debt before considering investing.
But when mortgage rates are low, as they are now, and alternative investments seemingly offer higher returns, the answer is not as straightforward.
I recently read a column by a British financial adviser, a self-proclaimed money expert. In early 2013, he had saved enough to pay off his mortgage — half was held in cash and half was in shares.
He didn't do it. Instead, he devised a plan to sell his shares slowly over the next eight years, hoping to squeeze out a bit more return before putting it into his mortgage.
The first thing to happen was he learned a lot about himself, "especially my ability to tolerate risk".
By late 2013, his shares were up 20 per cent and "the sun was shining" as he made his first scheduled withdrawal in early 2014.
News bulletins proclaimed record stock market highs through 2014, which made him start to feel nervous. He sold more shares in late 2014, so by early 2015 he was a year ahead in his annual withdrawal plan.
He pulled out more in April 2015 because the "stock market see-saw" made him feel queasy.
Turmoil hit again in June, August and September 2015 and he started wondering "what if I lost half of everything from here?" He then reached "an emotional Rubicon" where he realised he was taking risk he didn't need to take.
"If markets fell again, what would the downside look like? Painful. What did the likely upside look like? Meaningless, a few extra grand or so. I was not brave in the face of losses I had no business taking".
He sold all his shares the next week. That was in November, six years early. His mortgage repayment fund is now 100 per cent in cash, earning precious little. He says "no one can take that away from me now. Not even myself. It was one of the best decisions I've ever made."
I can understand his decision as, while his plan sounded fine in theory, it turns out he didn't have the stomach for the risk involved.
However, others who commented on his article were less understanding. One adviser captured the consensus view by saying: "Hmmm, with mortgage rates below 1.5 per cent and assuming expected share market returns of ±5% in a tax free portfolio, I can't see why on earth you would pay off your mortgage unless you thought your ability to earn was in serious jeopardy."
Others also questioned why the adviser chose to keep his funds in cash rather than actually paying off the mortgage: "If you are keeping your options open perhaps to take advantage of a market crash, then you've learned little about yourself as an investor!"
There is no right or wrong approach to this. Investor, know thyself. If repaying your mortgage allows you to sleep at night, do it. If you can tolerate risk, do it. Just know what sort of investor you are and act accordingly.