OPINION: Life is full of celebrations of various kinds – marriage, the birth of children, anniversaries and birthdays.
There is one life event which is a major financial milestone and that is the day on which your mortgage balance finally hits zero. It really is something worth celebrating.
The feeling of liberation that comes with having no commitments to the bank cannot be understated.
However, being mortgage free also creates a dilemma. What should you do with the money you were previously paying into your mortgage account each fortnight? If you have chosen to pay off your mortgage as quickly as possible, this could be a relatively large amount.
All of a sudden your savings hit a level never experienced before.
If you have planned your financial future well, your mortgage should be repaid well before your intended date of retirement to allow you to add to your retirement capital. Making the choice to pay off your mortgage before investing is a good one, with certain exceptions.
There are two types of investment that offer a potentially better return than paying off your mortgage – KiwiSaver and “leveraged” investments; that is, investments based on borrowed funds, such as investments in property or businesses.
If you have no interest in property or businesses, KiwiSaver should be your priority for investing until such time as your mortgage is paid off. The reason is quite simple. Your surplus funds should be invested for the best return.
For most people, the employer contribution and Government tax credit make KiwiSaver the investment of choice, as your contributions more than double in value even before investment returns are added.
Paying off your mortgage produces a return by way of the amount of interest saved. There are two important aspects to this return – it is the equivalent of a tax-paid return and it is guaranteed. For example, if your mortgage interest rate was 5 per cent, you would need to earn a guaranteed, tax-paid investment return of more than 5 per cent in order to beat the return offered by paying off your mortgage.
While there are investments that have the potential to return more than 5 per cent tax-paid, the return is not guaranteed.
If part of your mortgage was a line of credit, once your balance hits zero it might be an idea to leave the line of credit in place as a source of emergency funds. Then it’s a matter of deciding what to do with your surplus savings.
Money only has value when you spend it, however you can choose when you spend it. Your savings therefore need to be divided into two separate streams – money to be spent in the short term, and money to be spent in the medium and long term. Just make sure you get the balance right. Take care of your medium and long term needs first.
While bank deposits are a safe place for short-term money, you probably want to get a higher return for medium and long-term savings by investing elsewhere. Here are your broad choices:
You can add more to your KiwiSaver fund. Keep in mind that in most cases your money will not be available to you until you reach the official age of retirement and have been in KiwiSaver for at least five years. Make sure you have selected the investment option that matches your investment timeframe.
You can see a financial adviser who is authorised to give investment advice. The investment recommendations you get will depend on the adviser you see. Some advisers have a preference for portfolios made up of directly-held listed investments, while others may use predominantly managed funds. There are advantages and disadvantages to each approach, especially for the investment of regular small amounts rather than a large lump sum.
You can have a go at investing yourself. The role of an adviser is to help you with strategies to achieve your goals. There is a cost to this advice and if you feel confident you don’t need this help, you can create your own investment portfolio using a combination of retail managed funds, exchange-traded funds, shares and bonds. Investing in property and businesses are options, too.
There is one word of caution. Resist the temptation to pour your savings into doing up your home. It won’t give you the best return on your investment, you won’t be able to easily access your funds, and it’s much better for our economy if your money is invested in productive assets.
* Liz Koh is an authorised financial adviser and author of Your Money Personality; Unlock the Secret to a Rich and Happy Life, Awa Press. The advice given here is general and does not constitute specific advice to any person. A disclosure statement can be obtained free of charge by calling 0800 273 847.
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