KEY POINTS:
Conventional financial wisdom has long held that you should use any spare money - either lump sum or ongoing income - to pay off the mortgage. There are a few exceptions (KiwiSaver and other subsidised super schemes in particular) but as an adviser I have, for a long
time, told most people to get rid of the mortgage before starting to invest.
The thinking behind this has been that with mortgage interest rates sitting where they have been recently at around 9 per cent, you have to find an investment which returns more than 9 per cent after tax to be as well off. That is not easy to do - it is not impossible, but you have to take a lot of risk to do it.
However, mortgage interest rates have fallen and will almost certainly continue to fall. This means we have to review the numbers, re-examine conventional wisdom and look afresh at whether people should still pay off the mortgage in priority to making investments.
The investment return threshold that investors with mortgages need to meet to be better off than if they just paid down their mortgages is now nearer 6 per cent rather than the 9-10 per cent that it was just a few months ago. So if you have some spare money, the question is: Can you find investments that will give you 6 per cent after tax?
The answer is yes - shares and units in listed commercial property trusts should give combined dividends and capital growth over the next decade or so surpassing 6 per cent. These markets have already fallen greatly and although they may fall further, I would be surprised if the after-tax returns from shares and listed commercial property trusts did not exceed this return level.
In my view there is a substantial group of people who should pay as little off the mortgage as possible and get ready to invest the surpluses they have.
This strategy has some risk: First, interest rates could shoot back up again - unlikely to happen any time soon, I think, but always possible. Second, the markets may remain flat for years. There is a greater chance of this as there may indeed be little or no capital growth for a decade.
However New Zealand shares and listed property trusts offer such good dividend yields at present that even without capital growth, you are likely to beat that 6 per cent threshold.
Although there is risk, it is less than it was a year ago when the share market index was at 4000 (currently 2700) and mortgage interest rates were higher.
If you want to be safe, carry on paying off the mortgage as fast as you can - as rates fall, keep paying at least the same amount as you were when rates were high. You will get an effective 6 per cent return on your money after tax.
However, if you have secure income from your job or business and are prepared to take on risk, hoard cash and get ready to make some profitable investments.
The coming year or two will see some great investment opportunities for those who are bold. You will need to get good advice and think long term.
Although this recession will be hurtful for most, there will be a group who will use it to create real wealth. The time is probably not quite yet, but you should be getting ready to steal some bargains.
Each week financial author Martin Hawes shares strategies to help you grow your wealth. You can email finance questions to info@wealthcoaches.net or
andrea.milner@heraldonsunday.co.nz
