Due to a variety of reasons I will be in the position to overpay my mortgage next year (mostly due to stopping 2 x nursery fees).
4 years ago I put savings for our children into a couple of Vanguard Index tracker isas, which have averaged at 14.5% a year, which got me thinking. Instead of overpaying the mortgage, I could instead put it in isas. My thinking is worse case, it should atleast match the interest rate of a mortgage, likely best case it's atleast twice the return of any interest paid. Then after 10-15 years, it provides the opportunity to pay off the mortgage earlier than overpayment would.
Question is, what am I missing here and why isn't this more widely practiced (am I missing something?). Obviously I am aware there is a risk the trackers could go down but that seems low risk over the long term.
US Equity Index Fund Accumulation
FTSE Developed World ex-U.K Equity Index Fund Accumulation
'The value of your investment can go up as well as down'
That is the catch, and in 2008 and 2020 it was a big one
This winter I will primarily be investing in pies and gravy.
Question is, what am I missing here and why isn’t this more widely practiced
From a financial perspective you aren't missing anything. While interest rates are low overpaying the mortgage isn't the best use of your money. We still have a reasonable mortgage but have enough in savings in S&S ISAs to pay off most of it. No intention of doing so, though, and will hopefully be retiring early with those savings.
The main reason to pay off the mortgage instead is psychological. Not having that debt would certainly be a nice feeling. If you can take an analytical view on it then keep the mortgage, build your savings.
‘The value of your investment can go up as well as down’
That is the catch, and in 2008 and 2020 it was a big one
There is an element of risk but so far the markets have always bounced back. Those dips in 2008 and 2020 where rapidly followed by sharp rises. There's an on old thread on here about whether to buy Rolls Royce shares. Since 2020 they up about 600%
but so far the markets have always bounced back.
Absolutely. The risk is that you might want the money at the wrong time of course
Depending on whether or not the mortgage rate was fixed pre-Trusstercluck, the cost of servicing that mortgage may shoot up when any fix expires. As such, might be good to try and reduce the capital as much as possible in the meantime to take the edge off.
I do both fwiw, though our mortgage overpayment is purely the amount we’ve saved off nursery fees as various free hours kick in.
Don't forget you get tax relief on pension contributions. We don't know enough about your situation to really advise that, but it's an option and sometimes better than mortgage overpayments
As per previous poster the most efficient use of your money is to put it into a pension, given the tax relief in addition to investment growth.
Personally I spread it across the 3 - pension, mortgage overpayment and ISA. The other day I finally got to the fortunate position where my ISA is bigger than my mortgage but unless I have to I’m not paying the mortgage off for now, for the exact reason you specified.
Not really since presumably he has a repayment mortgage - Endowment mortgages assumed that a separate investment would pay off the mortgage with no other alternative to pay off the capital.
The comments about pension contributions are valid. I will probably end up deciding on a compromise (maybe 2/3rd invest, 1/3rd additional pension). The additional factor is that I might decide to use any investment to fund private schooling in 7-10 years time.
1. You won’t continue to average those returns over the long term
2. Look at the underlying holdings in those funds. You might be surprised by how much of it is concentrated in a handful of US companies.
@Andy_sweet - I have recently added three other funds to spread the risk.
Has anyone got any suggestions for an ethical investment? I want no fossil fuels, tobacco or anything that will harm the planet. I've had a Triodos Investment ISA for a few years and they're not doing great. One fund lost money while another has only gained a small amount, to the point where I'd have been better just putting it in a high interest account with Ecology Building Society that pays 5%.
Out and out growth is not my ultimate goal here but minimising my environmental footprint, and I have a civil service pension already.
Sensible
Question is, what am I missing here and why isn’t this more widely practiced (am I missing something?). Obviously I am aware there is a risk the trackers could go down but that seems low risk over the long term.
You are not missing anything. In my experience the majority of people have little clue about how any of this works, mortgages, pensions, investments etc.
Not really since presumably he has a repayment mortgage – Endowment mortgages assumed that a separate investment would pay off the mortgage with no other alternative to pay off the capital.
Which is why I said where he's heading, rather than where he is at.
Back to the OP's questions:
You're not missing anything - over a typical five years the percentage growth of stock market tracker is likely to be higher than your mortgage interest rate.
The reason more people don't do it is that people are not hugely savvy about investment, so cash sits in current accounts or the terrible high street savings accounts, which earn way less than the BoE rate and probably less than their mortgage.
It's not risk free, and you may get unlucky with timing, but it's not a zero-sum game. And investing it gives you choice about how to use the money later: you could still use it to pay off the mortgage.
that people are not hugely savvy about investments
I’d argue that “trustworthy of” needs adding to that sentence although more education would bring more confidence. Ive learned that this is what Rich people often do - let debt work for them.
There is another option - pay he mortgage ASAP then use the now spare money to invest. You’ll have more to invest although you’ll have lost a bit of time in the market, which is a key factor to growth - unless your mortgage redemption is fortunately aligned with a stock market crash.
You’re not missing anything – over a typical five years the percentage growth of stock market tracker is likely to be higher than your mortgage interest rate.
It’s not risk free, and you may get unlucky with timing, but it’s not a zero-sum game. And investing it gives you choice about how to use the money later: you could still use it to pay off the mortgage.
+1
There's a reason most pension schemes transition from stocks to trackers to cash as people approach retirement age. It's because <5 years the odds of you being forced to withdraw the investments during a downturn are much much higher. If you've got 10 years then you know that at some point from year 6 onwards you need to start thinking about guessing where the top of the market will be. 5 years then you've got very little room to maneuver.
Consider the worst case, that when the mortgage is due you either have to take out another 5 years on it and wait for your investments to recover, or take the hit and liquidate your investments at a loss and makeup the shortfall. The scary way to think about it would be "would I mortgage my house to make this investment", because that's the same question (penalty clauses aside) just with the inertia working the other way.
[edit] Although as Kryton says, that's largely how "rich" people do it, secure loans against assets because you'll get much better rates on a mortgage than on a business loan, then use that money to invest in something that will hopefully make a better return than the cost of the loan. Survivorship bias at play there though. Rich people may have gotten richer doing that. But bankrupt people have gone bankrupt doing it as well!
Maybe spread it around a bit - pay some off the mortagage, some into pension and some into a S&S ISA?
How you decide to weight/split that really depends, you could just do 33%/33%/33% but depending on your mortgage interest rate - as above you might want to pay less of your mortgage off to put into pension and ISA.
Putting more money into pension has it's own considerations too - good tax relief but how many years will you live after becoming elegible to claim it to make it worthwhile?
Same with S&S ISAs too... sp&500 is pure U.S. tech companies - whilst a good performer, is not very diverse - maybe a global fund weighted toward tech, and weighted toward the U.S would give you a bit more more diverstity with potential less risk and less reward?
The reason more people don’t do it is that people are not hugely savvy about investment, so cash sits in current accounts or the terrible high street savings accounts, which earn way less than the BoE rate and probably less than their mortgage.
I think this happens a lot - I was the same until about a year ago - mainly as I couldn't afford to save anything anyway, I think I've learned a lot in the last year, but it's a big meaty complicated subject with a lot of moving parts and considerations... I hardly understood how ISA's work, let alone what an EFT is or tax implications for pensions, capital gains etc. or much of anything really...
I'm mulling over simmilar scenarios myself too, so I'm just thinking out loud really.
It’s really difficult not to rely heavily on US stocks if you want a return. I’ve attempted to be at least a little diverse in both my ISA and Pension but both still end up about 80% US, 10% Europe and 10% rest of the world, plus a bit of Gold price trackers.
Not sure how else to do it. I’d love to do some research into Ethical funds but it would inevitably be at the cost of return.
Regarding high vs low risk I’ve long wondered whether the conventional approach makes sense. If you look at places where you can easily compare eg Vanguard, you can see that the higher Equity products almost always outperform the ‘safer’ ones, even during volatile times.
Unfortunately, this is true - just look at US vs UK stocks over the last 20 years 🙁
That’s just the Dow - if you include S&P 500 and Nasdaq then the difference is even greater.
I have a few green technology funds. Must admit I'm not totally sure what is in them. They haven't performed that well.
I think I'm leaning towards not being that worried about the ethics (within reason). My meagre pot isn't going to change the direction of the world. I'd rather do ok financially, retire early, then do something worthwhile with my time and spare cash that actually will help people or nature.
good tax relief but how many years will you live after becoming elegible to claim it to make it worthwhile?
You can put it in a drawdown pension where you take as much or as little as you like out of it each year, you just pay the appropriate amount of income tax on it. It doesn't have to be an annuity (although an annuity in theory should average out, it's an insurance policy against a long life so questioning "what if you don't live long enough" needs offsetting against "but what if you do").
Personally I pay into my workplace pension to make the 40% rate work as efficiently as possible, then I treat my socks and shares ISA as a 2nd pension. Although I'm effectively doing it after paying NI and 20%, in reality I would expect to be paying that 20% when I draw a pension anyway (obviously unlikely to be paying 40%). So what I lose in NI at 8% I get back in flexibility because the eventual aim is to use it to retire early, or it allows me to offset the pain of another Trussonomics style episode.
I take a very similar approach - plan to leave the pensions (Workplace and Private) until as close to state retirement age as possible. Before then plan to use the ISA plus renting the house out for a few years of travelling / minimal working after age 60.
Or something like that…
Can't tell you how valuable this sort of thing is for me. I'm trying to navigate my way to retirement, with I'm happy to admit a very poor grasp of financial planning along with a deep mistrust of IFAs. But basically it sounds like my pension and ISA planning is very similar to the guys above.
I'm a basic rate tax payer and find it difficult to convince myself that saving via a pension makes as much sense without the 40% uplift.
OP, thinking beyond a simple mortgage reduction is correct, but simply extrapolating recent Vanguard returns vs mortgage costs is rather less sound. Over a ten year timeframe the odds do favour equity investments, but perhaps not to the degree recently seen. I would probably do a little bit of debt pay down (because that is rarely the wrong thing to do) and some investment, both contributing to a SIPP (for the tax break) and ISA (for chance to access before retirement age).
Diversifying beyond the concentrated S&P is tricky. For all the hand wringing about the perceived dearness of the big companies that dominate the index it is quite difficult to see quite why they are going to seriously underperform. Why? because the ever-increasing trend to index trackers such as the Vanguard funds automatically pushes more money into the larger stocks: if the larger stocks are to actually underperform it will because there is a wholesale flight from equities in general and there will be no safe havens. Except gold perhaps. A compromise buy and forget tracker might be an equally weighted S&P product - there is still a lot of tech and the like in there but not to the same extent as the plain vanilla tracker.
Even without the 40% tax relief it’s still the only way you can save your gross income onto an investment. ISA may be tax free growth but you’re still saving your money after tax.
As many have said I spread it out amongst all 3 (mortgage overpayment, isa and pension) although I put by far the most into my Pension - although I am a higher rate taxpayer so it’s an easier choice.
Even without the 40% tax relief it’s still the only way you can save your gross income onto an investment. ISA may be tax free growth but you’re still saving your money after tax.
Yes, but it's tax free coming out of the ISA too.
Unless you don't qualify for a state pension, then any private pension will currently be taxed at 20% when you withdraw from it. The only difference is NI (and IIRC that depends if you're on a salary sacrifice pension or not).
e.g.
I pay £7360k (after paying £2k in tax and £640 in NI) into an ISA, then it goes up 100% I get £14,720.
I pay £10k into a pension, it goes up the same 100%, I get £16k and the government takes £4k.
The difference is 'only' that 8% NI at the end (and only if you're on a salary sacrifice scheme). And what's lost in NI is gained in flexibility. Over the next 20 years interest rates might go back to 8%+, tax breaks on pensions might become less generous, the house might collapse for uninsurable reasons, I might get terminally ill and fancy blowing it all. At which point having some 'cash' might be far more useful than that 8%.
It's also just plain old diversifying and spreading the risk.
is your mortgage at the lowest possible interest rate ie is it circa 60% LTV ? if not pay down your mortgage to ensure this
trouble with stockmarket is timing, but you should always invest today or yesterday.
ascertain your risk tolerance
workplace pension are good especially if your employer is giving 10% on top.
SIPPs are good for high rate taxpayers, to lower income taxable at higher rates, get the 25% relief then claim back the other 25% hence £1.25k investment costs you £750, but the rumours about lowering the tax free lump sum or even taxing it need to be heeded, how far are you off 57, does your family have a history of early death. need to consider is it worth it over the flexibility of an ISA
not having a mortgage is a good feeling, watching yourself lose 10-15% of your ISA/SIP value in 3-5 days, which i've experienced quite a few times is gutting.. just as you think life is good, some news comes out and boom, i find stocks are always quick down and slow up. thats said i'm well up on my investments and dividend income is now coming into their own.
Thanks TINAS, hadn't thought about it like that before. I'm not going to be sat on a massive pot when i retire but with the current rules it sounds like i'd do well to drawdown a decent tax free lump when i qualify at 58, is it now? then spend a couple of years maxing out my ISA allowance to top that up to an amount that might generate a decent amount of tax free income.
I pay £7360k (after paying £2k in tax and £640 in NI) into an ISA, then it goes up 100% I get £14,720.
I pay £10k into a pension, it goes up the same 100%, I get £16k and the government takes £4k.
Couple of comments on this:
- The 25% tax free lump sum means you net £17,000 out of your £20,000
- Your personal allowance means you can take £12,570 tax free before paying tax. This is very advantageous if you enter drawdown before you take your state pension.
Forgive my ignorance.. But if you take your pension as an annuity.. It dies with you...
So for example if you die 5 years after becoming a pensioner.. The pension provider will trouser the rest and you can't leave it to to a wife or children etc?
I might have got that wrong as I'm still very much a noob when it comes to investments and finance planning... If I'm right though... That's a pretty big consideration!
There is some good advice here, I got an interest only mortgage in 2006 and paid it off last year by investing.
The thing to watch with funds is the fees. Paying for example 1.5% in the beginning and when it's performing is fine, until you have a substantial sum invested and it's not performing.
@mattyfez you can get different types, so a spouse may get a percentage of the pension on your death, but you'll pay for that in a lower annual pension, than what you'd get if it was for just yourself.
i was playing with numbers a while back and i think i could get £10k a year or £8k a year if the pension moved over to partner on my death.
for a SIPP you need to name a beneficiary in the expression of wishes
Couple of comments on this:
3. the £10k invested isn't what you put in. as you'd get the 25% topup and High Rate taxpayers can claim back another 25%
thus the £10k investment would have cost you £8k, ie £8k cash put into SIPP and a £2k topup 65 days later (basic rate taxpayer), the high rate taxpayer can the get a cheque for £2k cashback after tax year end, hence £8k would have cost you £6k for a £10k investment..
TINAS's example assumes you are a basic rate taxpayer. The advantage is greater if you are a higher rate tax payer when saving and in all likelyhood a basic rate taxpayer when withdrawing.
Also this is incorrect
I pay £10k into a pension, it goes up the same 100%, I get £16k and the government takes £4k.
First you take £5K tax free, leaving you to pay tax on £15K. So the government will take a maximum of 3K.
In reality (if you have no other income) your tax allowance of £12570 means you only pay tax on £2430 which is £486.
So in TINAS example you have: ISA = £14720 vs Pension = £19514
Pensions are manifestly better than ISAs unless you need the money before you are 55 (soon to be 57)
James Shack has some very good videos and this one covers the question:
Should You Pay Off Your Mortgage or Invest? (A 50-year historical backtest)
Theoretically, investing is better than overpaying, but when you start to factor in risk that changes.
@mattyfez you can usually define another beneficiary and have them receive some or all of the benefits for a set period - obviously this means they're likely to be paying out for longer, so you'll be getting less out of them.
However there is no financial value remaining in the annuity that you can 'tale back out' as a lump sum if you die in just a few years.
I don't personally think annuities make a good solution for this reason (or at least not using the whole pot on one). You might be lucky and do well and live to 100, or you could be like my dad, who left work with a good plated final salary pension (admittedly a DB pension rather than an annuity)
He had only 9 years of drawing that before he died at age 69. Not very good value AT ALL.
My mum continues to get a %, but nothing left to hand on.
