Sunday, May 18, 2008


Recently, a listener posed this question: a well known, and usually very objective consumer magazine suggested that consumers who find they have ‘extra cash’ each month would be much better off (i.e. – would ultimately get a much better return) if they invested that money rather than using it to “pay down” their mortgage. At first glance, such would seem to be good advice. Unfortunately, such advice is too general to be considered a hard and fast financial rule of thumb. Why?

Two main reasons. It’s true, if you invest your ‘extra cash’ in a good investment vehicle that gives you a better return than your mortgage rate, than the advice is sound. However, what if you purchase a bad investment vehicle (always a possibility, and not one you can definitively know beforehand…indeed, one never knows whether an investment is good until one has owned it for a period – usually a long period – of time) Or, what if you purchase a “good” investment vehicle which – if it truly is safe – will have a relatively low interest rate (for example, a short term treasury bond). In either of those two cases, paying down your mortgage with your ‘extra’ cash would end up being a better (from a net return perspective) idea.

However, while extremely important, net return is not the only reason to choose an investment vehicle or strategy. What the consumer magazine doesn't take into consideration with this ‘advice’ is the psychological effect (which should not be neglected out of hand) that having the mortgage on one's home paid off has upon many people (i.e. albeit conservative, the “comforting” effect of that knowing you’ll own your home free and clear sooner gives to many home owners.)

The bottom line point, therefore, is two-fold. First, as we’ve noted many times, with very few exceptions (for the exceptions, see the BestMoneyinfo website), financial rules of thumb usually do not present sound advice. Second, when deciding when and where to invest one’s money, you should always start with a potential net return analysis (namely – which investment(s) will, or are most likely to, bring you the best net return, with the lowest – or, at least, an acceptable – degree of risk). However, when finalizing your decision(s) as to where to invest your money, your peace of mind (basically, your risk tolerance) should also be taken into consideration.