As a personal finance writer, I frequent a lot of money-related web forums. It’s a great place to ask and answer questions and generate new ideas for articles.
As we all know, the Internet loves to have Internet fights about all kinds of things. In the personal finance world, there is one topic that comes up over and over again, where there’s no consensus and opinions rage.
It’s the answer to this question: “If I have extra money, should I pay off my mortgage early or invest?”
The extra money could mean a one-time lump sum or a series of monthly payments. But no matter how the question is phrased, the discussion goes on and on. There’s never a clear answer, and the asker always comes away more confused than ever.
There can never be a definitive answer to this question because the two sides are arguing apples and oranges. Investors argue that investing is mathematically optimal (a fancy way of saying ‘you make more money’), while mortgage payer-downers argue that nothing beats the feeling of owning a paid-off house. Both are right.
The stock market has historically returned somewhere between 8-10% year over year. Not every year, but when you average out all the years, good, bad. and ugly, that’s the number you get. Most mortgages sold in the past five years have rates that are sub-6% (mine is 4%). The simple math says that in most cases case investing a spare dollar on a long-term time horizon is “better” than paying down the mortgage. In the case of my 4% mortgage rate, it’s twice as good. In fact, if I put $200 per month into an S&P 500 fund over ten years, there’s a $6,000 benefit over paying extra on my mortgage, before taxes and fees.
But to a certain mindset, investing money is just making a number bigger on a computer screen. Paying off a mortgage early provides real emotional comfort. To some, a monthly housing payment of $0 is the Holy Grail. It enables lower, more predictable expenses in retirement and allows its owners to sleep at night.
What also gets lost in this math problem is that a guaranteed return and a ‘historically likely’ return are not equal. If I pay down the principal on my mortgage, I’m getting a guaranteed 4% return. If I invest, I’m hoping that the next forty years of stock ownership is at least as good as the last one hundred. I hope that’s the case, and I personally think it will be, but it’s far from a prediction. When it comes to long-term forecasting, my crystal ball is as cloudy as yours.
The metaphor about birds in bushes applies here. What would you rather have: a dollar from me today, or a good chance at two dollars tomorrow based on my historical generosity?
I’m not convinced there is a clear right answer here. The whole argument confirms a basic point about personal finance: the math part is easy, but the emotional part is problematic.
What I can say is that both are very responsible ways of spending extra cash. Drop either of these plans on my desk and I’ll stamp them with a big picture of a thumbs-up. Since there is no worse financial plan than one you won’t actually follow, pick whichever one you’ll actually complete, even if it’s not “optimal.”
If you love watching your mutual fund account rise, go invest. If you get a buzz off of mailing in an extra principal payment on your mortgage, have at it. You probably will sleep better in a house you own outright. Just don’t tell the Internet.
Disclaimer: The views expressed are for informational purposes only and are not intended to serve as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell securities by FutureAdvisor. All expressions of opinion are subject to change without notice in reaction to shifting market, economic, or political conditions. The investment strategies mentioned are not personalized to your financial circumstances or investment objectives, and differences in account size, the timing of transactions and market conditions prevailing at the time of investment may lead to different results. Clients may lose money. Past performance is not indicative of future results. Investments in securities involve the risk of loss. Any tax strategies discussed should not be interpreted as tax advice and do not represent in any manner that the tax consequences detailed will be obtained. Clients should consult with their personal tax advisors regarding the tax consequences of investing.