For years I have said that people should use every spare dollar to pay down debt and to leave off investing for when all debt is gone.
The only exception to this basic rule is subsidised superannuation (e.g. KiwiSaver). People should contribute to the likes of KiwiSaver so that they pick up the maximum amount of subsidies but, apart from that, every dollar should go to retire debt.
The reason for this is quite clear: if you have some spare cash you could use it to repay debt. This would mean that your cash saves an interest cost of 5 per cent p.a. (assuming that 5 per cent is your mortgage interest rate).
If on the other hand, you invested this money, to be as well off you would have to get an investment rate of return of 5 per cent p.a. after fees and tax. That is no easy thing and probably requires a good bit of risk.
However, maybe I have been wrong that KiwiSaver is the only exception – perhaps there is another exception to the repay-debt-first rule.
That exception involves the value of investment education: using a little of that spare cash will give you investment learnings.
One of the problems of putting everything (other than KiwiSaver) to the mortgage is that you get very little experience of investing. This means that no one starts to invest in anything except KiwiSaver until the mortgage is repaid.
At some point in their lives, most people will have to become investors – but they may know little or nothing about the process of investment if they have spent most of their lives doing nothing but paying down debt.
People learn by doing. In my experience, a hands-on approach is best to understand investment. Sure, you can learn some things by reading, watching and listening but the best and deepest learnings come from putting things into practice. Perhaps the repay-debt-first rule is worth breaking for some investment practice and education.
In fact, you may find that the education is of greater value than the additional savings from repaying the mortgage. The younger you are when you get that education, the better off you will be.
In the old days, learning investment was less important: retirement was for a relatively short period of time and interest rates were higher. These things meant that many retirees simply put their savings in the bank and did not worry about a diversified portfolio.
However, with longer life expectancy and lower interest rates, such a strategy is no longer valid. The chances area bank deposit only strategy will not work and you will have to become an investor.
Therefore, I think that people should put a bit of their money aside and become investors early in their lives. The numbers suggest that you are better to concentrate everything to debt repayment but to take a small amount of money and invest it will give learning that will stand you in good stead later in life.
Martin Hawes is the Chair of the Summer KiwiSaver Investment Committee. He is an Authorised Financial Adviser and a disclosure statement is available on request and free of charge, or can be found at www.martinhawes.com.