Pay off the mortgage, build your investment portfolio or focus on building your superannuation fund?
In what seems to be an extremely unlikely outcome, given the economic impacts of the COVID-19 pandemic and subsequent lockdowns, a large proportion of Australians have managed to have more money in their pockets. With fewer opportunities to spend, combined with an increase in social assistance benefits like JobKeeper and JobSeeker, household savings rates increased in the June 2020 quarter to 19.8 per cent, up from 6.0 per cent1. Moreover, household savings in June were 10 per cent higher than in February and up 31 per cent from a low point in January2.
With many Australians suddenly finding themselves with an increase in their savings, we are being asked more often than ever how best to use those extra funds – pay down the mortgage, start an investment portfolio or invest in super.
The quick answer is – it depends!
The right strategy will depend on your circumstances and what you are trying to achieve financially, and this is where good financial advice is essential. To help you get started, there are some common questions you might want to consider when working out the right strategy for you.
Home loan versus building your investment portfolio
There are significant benefits in investing outside your existing home, especially at the moment with the current low interest rates. In order to manage this effectively you do need to ensure you have the right advice and weigh up all the scenarios.
By building a diverse investment portfolio you will effectively spread your risk and increase the opportunity for financial gain. There are also many tax implications that will need to be assessed.
Factors to consider when planning to build an investment portfolio
- Your return rate needs to be higher than your home loan rate
- How easily can you divest the assets if you unexpectedly require the funds?
- Decide on your timeline and consider your future plans
Most people have a threshold in terms of how much debt they can cope with (both from a financial point of view and an emotional point of view). In the past, with interest rates a lot higher, you may have decided to focus on paying off the mortgage as the first priority.
It is worthwhile in the current market to consider your options. Investing prior to paying off your mortgage may allow you to see returns sooner and therefore pay off your mortgage a lot sooner as a result.
Home loan versus retirement
When considering the option of putting your money into super, it is worth comparing the interest rate you are paying on your home loan to the rate of return on your superannuation fund. With home loan rates at historic lows, you may find that the returns on your super are potentially higher. If you haven’t reviewed your home loan for a while, you might not be taking advantage of these record low rates. If that’s the case, you may wish to speak to a mortgage broker to see if you could be saving even more by refinancing to take advantage of the lower rates.
The upside of contributing to super is that you gain the benefit of compounding interest, which helps to grow your retirement savings faster. Even small amounts make a big difference, and the longer you save, the more interest you earn. Depending on how your super is invested, it may grow significantly over time.
If there is one thing 2020 has taught us though, it’s that no-one can predict the future. Markets will vary over time, and the returns you get on your super today may be different to those you receive in the future. The benefit of working with a financial planning team like us is that we can help you stay on track to achieve your financial goals, especially as things change over time.
Depending on your marginal tax rate, contributing to super may also be an effective way of reducing your overall tax bill. That’s because the repayments on your mortgage are made from ‘after-tax’ dollars, whereas contributions to super can be ‘pre-tax’. Australians can contribute up to $25,000 per annum pre-tax to their super, and these contributions are taxed at 15% when they are paid into your super fund. One thing to note – if you earn over $250,000 you may have to pay an additional 15% tax on some or all of your super contributions.
Regardless of the strategy you choose, it is important to regularly review it. Markets will move over time; interest rates can vary, and your circumstances will change over time. The right strategy today may be different in the future. That’s where we can help – we can work with you to get the right strategy in place for your situation today, and then help you stay on track with your financial goals as things change.
Once you are comfortable that you have your home loan in order, there are a couple of factors you might want to consider when deciding where to direct those extra savings:
1. Loan size and life of your loan
Paying off more of your home loan at the start of a 30-year loan will have a much bigger impact on the total cost of that loan than it will if you pay off more at the end. Similarly, the total interest you pay over the life of the loan will be less if you can start to make additional repayments early on, as interest on home loans is calculated daily.
2. Peace of mind
For some people, they are looking forward to the day when they know they own their home outright, and so paying off the mortgage helps them achieve that peace of mind sooner.
3. Future plans
Depending on where you are in life, you may already be planning for significant changes – starting a family or planning to downsize. The right strategy will vary depending on those plans – if you think you will need to access those extra savings before you retire, you may be better to set up an offset or redraw facility on your loan. This would mean you still get the benefit of the interest savings but can access the funds when you need them. In comparison, contributing to super means you can’t access those funds until you reach preservation age or certain conditions of release are met.
A Tribel adviser can help you decide on the right approach to building a manageable investment portfolio and advise on the best approach for your future.
1ABS, Australian National Accounts: National Income, Expenditure and Product, June 2020 quarter
2ABC News, Savings increase could either mean a deeper, longer recession or faster recovery, 9 June 2020, https://www.abc.net.au/news/2020-06-09/bank-savings-go-up-raising-risk-of-deeper-longer-recession/12332250