Mortgage, debt, investing: Where should you put your extra money?

Mortgage, debt, investing: Where should you put your extra money?

Households with some extra money left over at the end of each month could look at paying down debt, mortgages or strengthening their investment portfolio.

Borrowing rates have skyrocketed and the stock market has taken a tumble this year, leaving some Canadians wondering where the best place to allocate some extra cash at the end of the month is.

There’s no doubt that the skyrocketing cost of living has put a severe strain on many households’ budgets, but those who are able to keep their expenses low and cash flow positive may have to decide whether to put those extra dollars toward consumer debt, a mortgage or an investment portfolio.

Since everyone’s life situation is unique, there are a number of factors to consider before deciding which area to prioritize.

According to Bruce Sellery, personal finance expert and founder of Moolala, one way to gauge the health of your finances and identify gaps that need to be addressed is to use a “priority pyramid.”

Modeled after Maslow’s hierarchy of needs, the priority pyramid is a hierarchy of financial basics: Have positive cash flow in your monthly budget, eliminate consumer debt, contribute to savings, optimize tax benefits, invest and finally optimize return on investment.

“If they have credit card debt, they don’t have extra cash. They may think they do. But they don’t,” Sellery said. Yahoo Finance Canada in a telephone conversation.

Before an individual can put extra money toward a mortgage or investments, he says paying off credit card debt should be a priority, as many cards have an interest rate of around 20 percent.

Once the basics of budgeting are in place, such as eliminating high-interest debt and building an emergency fund, Canadians can “earn the right to move up the pyramid,” he says.

Mortgage vs Investing

One factor to consider when you’re faced with choosing between lump sum mortgage payments or boosting your investment portfolio is whether the mortgage rate is fixed or variable, Frank Gasper, a wealth adviser and founder of CSR Wealth Management, said by phone.

As interest rates have skyrocketed this year, homeowners who previously opted for the very popular variable rate have seen a significantly higher amount of their monthly payment go towards interest. Many had their amortizations extended or their payments increased to match the higher interest rate.

However, for a homeowner who has been able to secure an ultra-low fixed rate of two per cent, for example, Gasper says it “doesn’t make sense” to pay off a mortgage when investments offer a higher return.

“If their risk tolerance allows it, it’s good to start putting money into the market,” he said. He added that even risk-averse investors can look to safer assets such as guaranteed investment certificates (GICs), which currently offer yields of around 4.5 percent.

However, fixed-rate homeowners may have to remortgage in a higher interest rate environment in the coming years, which could tip the scales so that lump sum mortgage payments are a wiser choice compared to investing, Gasper adds.

Sandy Yong, personal finance writer and book author Master of moneyhe also says he prefers the investment option, although he stresses that all financial situations are different.

“I would choose to invest in the stock market because you never know when the next market is going to drop by double digits,” she said by phone.

“The market has been pretty down all year and could it go down? Yes, of course. It could be a lot worse, but if you have that long-term mindset, where do you invest that money long-term, whether it’s for retirement or other long-term goals , then this opportunity is hard to miss.”

The S&P/TSX composite index is down about 16 percent from its peak earlier this year as higher rates and fears of a looming recession hammered stocks.

Money thinking

Sometimes simple math can be the best choice, says Moolala’s Sellery, such as when the return on an investment clearly exceeds the interest charged on the mortgage. With mortgage rates now hovering around five percent, the math is less clear.

“These days, math is neck and neck. So it’s not about math. It’s about thinking, in my opinion,” he said.

“If the math is dirty or, you know, you’ve looked at your circumstances and it’s not clear, then it’s a mindset. What makes you feel better? Some people feel better with a lower mortgage balance.” Some people feel better with a larger investment balance.”

Taking a holistic view, Sellery suggests that someone looking to retire early would prioritize paying off their mortgage, while someone who intends to work part-time during retirement might lean toward a larger investment portfolio.

Meanwhile, CSR Wealth’s Gasper says age and risk tolerance play a role in the decision-making process, and that for young people in particular, there are three financial goals to aim for.

“If we’re talking to 30-somethings, then that’s an important factor. Increase your cash flow, pay as little interest as possible and invest for the long term.”

Michelle Zadikian is a senior reporter for Yahoo Finance Canada. Follow her on Twitter @m_zadikian.

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