I have been offered a fee (of the scale of two steak dinners for two/box of Cuban cigars level) to answer the following question:
Basically I\’m wondering how to weigh up the pros and cons of using spare income for either
a) investing for my retirement (probably as index trackers in an ISA)
b) paying off mortgage.
Both are a form of investment- deferring present consumption for future benefit- but which, I am wondering, likely to put me in the best position in a decade or so from now?
With the obvious proviso that I\’m neither a tax nor investment advisor here goes:
My personal preference would be to pay down the mortgage.
Now both are, of course, deferrals of current consumption and as such should make one better off in the future.
And certainly, index trackers in an ISA are the both tax logical and individual investor logical ways to save for the future.
Tax because one can put the money in tax free and, as we also know, any dividends reinvested or capital gains over the life of the ISA are tax free. Trackers (and make sure it\’s a low load one) because the efficient markets theory does indeed hold in its weak and semi-strong forms. Markets, when considering what prices should be in a market, are efficient at processing the information about what prices should be in a market.
It is thus (leaving aside the strong form of EMH, where even this doesn\’t hold), unless you have special information unknown to the rest of the market, impossible on anything other than a statistically random basis to consistently beat the market.
So why would I prefer to pay down a mortgage? At least in a tracker there is the possibility of a rise in the capital value…..
Well, it\’s true that there are no longer tax advantages to mortgages. However, given the way that my income bounces around (the evidence of the last decade is that it can go from £20k one year to £130k the next and then back again) it is uncertainty of income which is my major concern. And a mortgage is a fixed cost (well, as long as interest rates stay stable). So, in those good times, rather than socking money away that I cannot touch for 10 years (?) I prefer to reduce what I know I\’m going to have to pay in a year or two when, depending upon the vagaries of the freelance and or scandium markets, I may or may not have the cash flow to keep the mortgage payments up to date.
Which brings us to two further points.
The first is that we are all, as I think we know, in somewhat uncertain financial times. As someone who has lived their entire working life with such uncertainty, here\’s my recommendation for how to deal with it.
Pay your mortgage forward (we are, of course, all assuming here that there ever is a surplus over current expenses: but then that\’s obvious from the very question at the top) by three months. It\’ll cut the amount of interest you pay over the life of the mortgage a bit: but much more importantly, if there is an interruption to your income this will give you three months grace with the Building Society before they start to get nasty.
\”You know I paid you two mortgage payments one month last year? Well, I\’d like to skip a month now\” works much better than \”I\’ll pay two months in the future if I can skip one now\”.
You should also (again, subject to resources) have a nice high interest (I know, it is to laugh these days!) account that has three month\’s worth of non-mortgage living expenses in it.
Finally, you should of course pay down all of your higher interest consumer and credit card debt. Any store cards, HP on a car lease (if you can do it) and so on, pay them all off.
And finally finally, I think it\’s fairly obvious that interest rates are going to go up at some point. Whether the withdrawal of QE will crater share prices or not I don\’t know (see EMH above) but clearly and obviously mortgage interest payments are going to rise in a year or three. So while there is spare cash around from the current low rates, reduce the amount you\’re going to have to increase payments then they rise.
And as a stock picker? Well, there\’s that pesky EMH in there. But FTSE 100 these days is really a barometer of the global economy, not the national one. FTSE 250 or 350 (??) is more about the UK. I don\’t think it\’s all that controversial a point to think that the global economy is going to do better than the UK one over the next 10-20 years. It\’s what the whole idea of climate change is predicated on for example. If I were to be buying trackers I\’d go for global, not local ones.
So, now over to the readers here who obviously know more about this than I do. What is the real advice in this position?
And finally, finally finally, do send me an email if you have further questions to be answered in this format. Bile and venom can be added to taste. I am even, for a price, willing to let out Timofei, my mirror image alter ego….