Should you pay off your mortgage or invest your spare cash? It’s a long-running debate with several possible answers.
I don’t like having a mortgage, but I think there are powerful arguments in favour of investing from the youngest age possible. In this article, I’ll explain what I’ve chosen to do to solve this problem.
Debt: should we get rid of it?
If you have debt such as credit cards or loans, then in general I would aim to pay these off before starting to invest. The reason is simple. The interest costs of the debt are likely to be bigger than any profits you make from investing.
With mortgages, it’s a little different. Firstly, most of us will never be able to buy a home without a mortgage.
Secondly, mortgage debt is very cheap these days. I’ve seen mortgages advertised recently with interest rates of less than 1.5%. Even some cash savings accounts can keep pace with this. It certainly shouldn’t be hard to earn more than 1.5% each year by investing in the stock market.
So in general, I wouldn’t wait until you’ve paid off your mortgage before you start to invest.
However, there’s a second, more powerful reason why I think we should start investing while we still have a mortgage.
Compounding: a hidden superpower
When you’re investing, time is your friend. It gives you the chance to benefit from compounding. This may sound technical, but it’s pretty simple.
Compounding means earning income from previous years’ income. For example, if you have a savings account, you’ll receive interest each year. If you leave this in the account, then the following year you will be paid interest on the previous year’s interest.
It’s the same with stocks. If you use your dividend income to buy more shares, then the following year you will receive dividends from the shares you bought with the previous year’s dividends.
Compounding is incredibly powerful, but it takes time to work. For example, if you saved £500 per month at 8% for 10 years and reinvested all the income, you’d have about £86,900.
If you saved £500 per month for 20 years, you’d have about £247,500. But if you saved £500 a month for 30 years, you’d have £679,700.
After 30 years, you’d only have paid in three times as much as in the first 10 years. But your investment would be worth nearly eight times as much as it was after 10 years.
That’s the power of compounding. The only catch is that you need to give it time. If you don’t start investing until you’ve paid off your mortgage, you’re losing lots of valuable time.
What I do
Although I want to pay off my mortgage early, I don’t want to miss out on the big gains that compounding can provide.
So I’ve decided to live with the mortgage for longer so that I can build up a retirement fund for the future. Most of my cash is invested in high-yield dividend stocks that I think will provide a reliable income for a long time.
By focusing on dividend stocks, my hope is that I won’t need to sell anything when I want to retire. Instead, I’ll be able to start withdrawing income directly from my stock portfolio, without touching my capital.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.