Covid-19 has changed the way you weigh your options. Photo / Kenny Rodger
COMMENT:
The Herald's Cooking the Books personal finance podcast is here to get you the tips you need to weather the financial storm. Hosted by Frances Cook, with a new expert on each episode.
The weird thing about the current situation is how split the financial world is.
These are, of course, very difficult times for many right now. For some, just the uncertainty is proving a money killer.
But for those who still have their job, there are actually quite a few opportunities to get ahead.
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So one question has been flooding my inbox more than others; if you're fortunate enough to have some spare cash right now, would you be better off putting it on the mortgage, or investing it into something like the share market?
Now in times gone by, there was a simple answer to this question. But stay tuned, because good old Covid-19 has, of course, put a twist on things.
When you're paying off debt, you can consider the interest rate it would have cost you, as your "return", or profit.
So if a mortgage was fixed at seven per cent, then that's a seven per cent return.
The share market, meanwhile, hits an average of seven per cent return per year. You might think that means they're equal options.
But no. Don't forget, with shares you need to take something off for fees, and taxes. About two per cent might be lost there, as a rule of thumb.
So now, the mortgage looks better.
Then take into account volatility, which just means how much something goes up and down. The shares might give an average return of seven per cent per year, but you don't know which years.
So one year it might be up by 15 per cent. The year after it might be -4.
It all balances out. But you don't know what the timeline will be.
Meanwhile, the mortgage is locked in. You're paying that interest rate, year after year. It's a sure thing.
So, in times gone by, the mortgage was the one that made most sense on paper.
But of course, it's time to whip out the sentence you'll have heard constantly over the last few months. Say it with me now: "We're in unprecedented times."
Interest rates have hit rock bottom and started drilling. You could well get a mortgage rate of 2.5 per cent from one of the major banks right now.
That means, there's a good argument for shares being the better option, even after fees and taxes.
After all, investing while the market is low could mean snapping up bargains, as long as you are careful and use a cool head. (See other Cooking the Books podcast episodes for more on how to do that.)
You don't want to delay your investing journey for too long, because the issue with shares investing is the need for more time. The earlier you start, the more money you can make with the least effort.
That's thanks to compound interest. If you make money thanks to shares and put it back into the share market, your investment will soon boom in value with very little effort from you.
The trick is that you need time. As much of it as possible. So the sooner you can start, the better.
So which is the right answer?
Like so many things personal finance, it's personal.
The mortgage is a safe and secure option. One step closer to paying off the roof over your head, and knocking years off your future bills if you put extra on it now.
The shares are a great investment for the future, able to provide income in the future, and going for bargain prices at the moment.
Of course, there's a middle option here too.
Why not a little of both?
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'Debt becomes more like a rent payment that people get so used to paying.'