Season 5, Episode 3
Should you pay your mortgage down or invest?
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Glory Gray
Hi, everyone, I’m Glory Gray and welcome to the Women’s Wealth Canada Podcast.
How are you doing? Really, how are you doing? I’ve been thinking about you all and having some conversations with some of you and I want you to know that everything is going to be alright.
Change is in the air in our country. For many people, change is scary. I was talking to a good friend about this. She was feeling some fear about the direction the world was headed and specifically where our economy was headed in Canada. And I told her that here’s the thing about money. Money never disappears. It is simply always in motion. Someone somewhere is making money right now in all markets, in all geopolitical situations.
Sometimes, I hear media outlets say “we are all doomed and here’s why.” The thing that doomsayers don’t consider is that nothing is ever static. Yes, bad things can happen and we can’t anticipate them. But equally as important to remember is that, at that same moment in time, good things and opportunities are happening and we can’t anticipate what those will be either. Every event has two sides to it. The pandemic was a terrible, trying time. But think of all the new industries and possibilities for how we live and work were created during that time or arose from it.
So, rather than worry about how an event you cannot control is going to affect you negatively, flip it around and think about how it could provide an opportunity in the future and how you can prepare for that possible opportunity.
This idea that opportunities and challenges are always around us is one reason we create a diversified portfolio.
First, let me review what a diversified portfolio is by telling you what it is not. I was analyzing a new client’s investment accounts and I asked her if she thought she had a diversified portfolio. She said yes, she did. I asked her why she thought that. She said she had a little money at the bank and she had a little money at one investment advisor and she had a little money at another investment advisor so she was well diversified. That's not a diversified portfolio and I've heard this from more than one person, not just her.
Having a diversified portfolio means that you are invested in many different types of investments and investments that are in different countries. The different countries piece is important because no country is ever in a recession or growth period at the same time as other countries, thank goodness. Even during times of widespread global recession some countries are experiencing different points of growth and downturns at different times.
Did you know that until 2005, the Income Tax Act restricted what you could invest in in your RRSP? Back then, only between 10% and 30% of your account could be in foreign investments, including the US. That is totally against the idea of a diversified portfolio, so thankfully, they got rid of that rule.
A good metaphor for a diversified investment portfolio is a well-balanced diet.
Just like a nutritious meal includes a variety of food groups—proteins, carbs, vegetables, and fats—each contributing its own unique nutrients—your mutual fund or ETF investment portfolio needs a variety of fund asset types (stock funds, bond funds, real estate funds, etc.).
If you only eat one type of food, like only eating carbs, you're missing out on the nutrients you need for long-term health. Your body can become vulnerable to risks in that one area, like diabetes.
Similarly, if you only invest in one type of asset, your portfolio could be vulnerable to risks in that one area. Or, you could miss out on opportunities another asset can provide.
By mixing things up, you’re ensuring that even if one food type or investment type isn’t performing well, others are there to balance things out.
Here’s another tip about investing while we’re at it. Money flows from the impatient to the patient. Let me say that again money flows from the impatient to the patient. When it comes to investing it’s best to try to strip the emotion out of it and stick with your plan, whatever it is.
For example, let me tell you how some big institutional investors like pension fund managers invest. They often have a wish list of stocks they want to buy. But, sometimes those stocks are too expensive and it doesn't make sense for them to buy them at that price. They don't think the stocks will give them the kind of return they want if they buy them at the current price. But they have this wish list.
When markets go down, good stocks sometimes go down in price along with the whole market. That's when those stocks that they had on their wish list are now on sale at a good price. That’s when large institutional buyers like pension plans snap them up. They have an idea of what the price should be. The price comes down to what they think it should be and they buy that stock because it's now on sale.
And you can understand that, you recognize a good deal when you see it. There’s a brand of coffee beans at Costco I love. I know what the price is normally and when they go on sale, I buy them. That's the way to look at markets. Instead of being upset when markets go down, realize that things are on sale and if it's something you're going to be holding for a long time, you may want to consider buying it on sale.
So, going back to my point about how money flows from those who are impatient to those who are patient, when markets go down, the impatient investor is more likely to say, ‘everything is down, I am out of here, sell, sell, sell. I don’t have time to wait.’ They are more likely to sell at the worst time because they are impatient. While the patient investor is saying, ‘no problem, I’ll buy that low priced stock for you. I know that it’s a strong stock and with time, if I’m patient, I can make money.’
That’s what I mean when I say money flows from the impatient to the patient.
Let’s talk today about a question I often get. Should you pay down your mortgage or should you invest your money?
I had a client who was very surprised to receive an inheritance from her grandfather when he passed recently. She was not expecting this. Here she is with two young children, a mortgage and many years to go before she retires. She felt a bit stuck because she suddenly had this responsibility for making the most of this inheritance. What is her best course of action, should she use that money to pay down her mortgage or invest it?
I’m going to tell you right now, straight up, that the answer is going to be different for everyone. But, when I prepare a financial plan, I am usually asked to prepare at least one scenario of what will happen if a client pays down a mortgage rather than invests. So, we can talk about some of the variables to look at.
And there’s the investment answer to that question and there’s the psychological answer to that question. Let’s look at the investment side first.
The rule of thumb is that if your mortgage interest is >5%, you should pay down your mortgage with an inheritance rather than invest. That rationale is related to the fact that if you maintain a lower risk, balanced investment portfolio, you can expect to earn about 4%. So, if you can get a mortgage for 2% and invest the rest of your money at 4%, you’re earning a net of 2%, right? You earn 4% and you pay 2% to the bank for your mortgage. So, you’re still earning 2% by investing your money.
But if your mortgage is 5%, you’re losing 1%. You’re paying the mortgage bank 5%, so if you can only earn 4% on that money, you’re losing 1% on the money you’re investing.
When mortgage interest rates were over 5% recently, I saw a lot of people putting more money towards paying down their mortgage faster. But, now that mortgage rates are back down, more people are better off taking a mortgage out and investing the money they would have used to pay cash for a house or put a big down payment on a house and instead they are investing that cash. Now they’re earning enough money to cover their mortgage payment and still grow their savings.
But, not everyone sees this as a pure money decision. In the minds of many of us, debt is debt and we hate it. You may simply not want any debt hanging over your head. That’s okay too, it’s a personal decision.
I could explain to you again and again how this math works to show that you’ll do better investing rather than paying down a mortgage if you have a low interest rate, but if your answer is still ‘Yes, but I don’t want debt,’ then pay down your mortgage faster. Or split the difference. You could use some of the inheritance to pay down the principal of your mortgage and invest some.
If you do have a lump sum of money, like an inheritance, and you decide to use it to pay off your mortgage faster, it may be best to wait until your mortgage is up for renewal, because Canadian mortgages can contain prepayment penalties. If you pay too much off too fast, you may incur a penalty.
If you don’t have a lump sum of money, like an inheritance, another strategy is to pay down your mortgage by increasing your monthly payments so that the extra amount is applied directly to the principal.
Or, you can change from monthly payments to bi-weekly payments. When you pay your mortgage every two weeks instead of every month, you pay an additional monthly payment every year because you’re dividing the monthly payment in half and then making 26 payments.
Before you decide which strategy to use, you’ll want to talk to your lender to find out the best way to do this to avoid prepayment penalties.
I want to leave you with this thought today. As long as you are on this earth and of sound mind, never give up learning and never give up on your goals. Stay curious.
At age 23, Oprah was fired from her first news reporting job.
When J.K. Rowling was in her late twenties, she was a single parent living on welfare.
Julia Child didn’t publish her first cookbook until she was age 49, and got her own cooking show at age 51.
Grandma Moses didn’t begin her painting career until age 78. After her husband died, she started creating beautiful artwork with needlepoint and quilting. But her arthritis got bad, so she found she could hold a paintbrush easier. She painted right up until her death at age 101.
My most successful clients always stay curious and engaged in the world.
Never tell yourself you’re too old to make it.
Never tell yourself you missed your chance.
Never tell yourself that you aren’t good enough.
You can do it.
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I'm Glory Gray, your personal trainer for financial fitness telling you to take charge of your finances, plan for the future but most of all, enjoy today. Bye for now.
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This podcast is for informational purposes only and should not be construed as investment, tax or legal advice. It is not an offer to sell or buy or an endorsement, recommendation or sponsorship of any entity or security cited. Mutual funds offered through Portfolio Strategies Corporation. Other products and services provided through Glory Gray Wealth Solutions.
