It’s a choice that’s plagued generations of homeowners – pay off the mortgage faster or use the extra cash to invest in ASX shares? It’s a devilishly vexing choice, as there are good reasons to go down either path. But I think the current investing environment we are navigating through in 2020 has tilted the playing field in one firm direction. Let’s dive in.
So, the family home is the largest asset of many Aussie families. And it’s normally a great asset to own. Paying a mortgage instead of paying rent builds your long-term equity. And a paid-off house lends security, certainty and the ‘my-home-is-my-castle’ effect. No one can evict you, ask you to move or tell you to mow your lawn.
But mortgage interest is not normally tax-deductible in Australia (at least on the family home). That means that by making extra payments on your mortgage above the minimum instalments, you are effectively getting a return on your investment of whatever your mortgage interest rate is. If you have a 2.5% mortgage (increasingly common in our era of record low interest rates), then you are effectively getting a 2.5% per annum return on extra repayments. That looks pretty decent against what you can get from a term deposit or a savings account right now.
However, it doesn’t look as good when you consider the alternative. See, investing in anything is an exercise in opportunity cost. When you invest $1,000 in option A, you give up the opportunity to invest that $1,000 in option B.
Or ASX shares
Let’s take a simple ASX share investment as an alternative. The Vanguard Australian Shares Index ETF (ASX: VAS) is an index exchange-traded fund (ETF) that holds a basket of shares representing the largest 300 Australian public companies. It most of the Aussie companies you’d know, from Commonwealth Bank of Australia (ASX: CBA) to Woolworths Group Ltd (ASX: WOW), Telstra Corporation Ltd (ASX: TLS) and even Afterpay Ltd (ASX: APT).
It’s one of the easiest shares you can own because it simply tracks the Australian share market over time and automatically adjusts itself so it always holds large shares in the largest ASX companies.
Since its inception in 2009, this VAS ETF has returned an average of 8.4% per annum. That means that if you instead invested those extra mortgage repayments into VAS instead, you’d be getting an effective return of 8.4% per year, instead of 2.5%. Of course, that assumes VAS continues to average at 8.4%, which isn’t guaranteed.
That difference can be worth a lot. According to MoneySmart’s compound interest calculator, if you invest $10,000 and get a 2.5% return over 20 years, you’ll end up with $16,479 at the end. But if instead you manage an 8.4% return, you’ll instead have $53,342 for your efforts.
Of course, these numbers are all hypothetical. But the logic behind them is sound, in my view. I think you’re almost always better off investing any surplus cash you might have into ASX shares rather than your mortgage. But if having a paid-off roof over your head as soon as possible is important to you, then there’s nothing wrong with just focusing on your home as well. There’s a lot of value in a good night’s sleep! Have the thought and discussion though, it’s a worthwhile conversation to hold, at the least.
Where to invest $1,000 right now
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Motley Fool contributor Sebastian Bowen owns shares of Telstra Limited. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia owns shares of AFTERPAY T FPO and Woolworths Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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