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Borrowing rates have skyrocketed and the stock market has fallen this year, and some Canadians are wondering where the best place to allocate the extra money left over at the end of the month.
There is no doubt that the soaring cost of living has put a strain on the budget of many households, but those who are able to keep their expenses down and maintain a positive cash flow may have to decide between investing those extra dollars in their consumer debt, mortgage, or investment portfolio.
Since everyone’s life situation is unique, there are a number of factors to consider before deciding which area to prioritize.
According to Bruce Sellery, personal finance expert and founder of Moolala, one way to assess the health of your finances and identify gaps that need to be filled is to use the “priority pyramid.”
Inspired by Maslow’s hierarchy of needs, the pyramid of priorities is a hierarchy of financial fundamentals: Having a positive cash flow in your monthly budget, eliminating consumer debt, contributing to savings, optimizing tax benefits, investing and finally , optimize returns on investment.
“If they have credit card debt, they don’t have extra money. They may think they have. But they don’t,” Sellery said. Yahoo Finance Canada in a telephone interview.
Before a person can invest extra money in a mortgage or investments, he says, paying off credit card debt should be the priority, as many cards have an interest rate of around 20%.
Once the fiscal basics are in place, like eliminating high-interest debt and creating an emergency fund, Canadians can “earn the right to climb the ladder,” he says. .
Mortgage vs investment
One of the factors to consider when deciding between making lump-sum payments on a mortgage or bolstering an investment portfolio is whether the mortgage rate is fixed or variable, Frank Gasper, wealth adviser and founder of CSR Wealth Management.
As interest rates have skyrocketed this year, homeowners who previously chose the popular variable rate have seen a significantly higher amount of their monthly payment go towards interest. Many have had their amortizations extended or their payments increased to account for the higher interest rate.
However, for a homeowner who was able to lock in an ultra-low fixed rate of, say, 2%, Gasper says it “doesn’t make sense” to pay off the mortgage when investments offer a higher return.
“If their risk tolerance allows it, it’s a good idea to start investing money in the market,” he said. He added that even risk-averse investors can turn to safer assets such as guaranteed investment certificates (GICs) which currently offer returns of around 4.5%.
Homeowners with a fixed rate may need to renew their mortgage in a higher interest rate environment in the coming years, which could tip the scales to make lump sum mortgage payments the smarter choice over investment, adds Gasper.
Sandy Yong, personal finance writer and author of The master of moneyalso says she prefers the investment option, although she points out that all financial situations are different.
“I would choose to invest in the stock market because you never know when the next time will be where the market drops in double digits,” she said over the phone.
“The market has been pretty low all year and could it go down further? Yeah, sure. It could get worse, but if you have that long-term mindset where you invest that money for the long term, let that whether for retirement or other long-term goals, this opportunity is hard to pass up.”
The S&P/TSX Composite Index is down about 16% from its peak at the start of the year as higher rates and worries about a looming recession hit stocks.
money mindset
Sometimes the best option may come down to simple math, says Moolala’s Sellery, such as when investment returns clearly outweigh the interest charged on the mortgage. However, with mortgage rates now hovering around 5%, the math is less clear.
“The math these days is neck and neck. So it’s not just about the math. It’s about the mindset, in my opinion,” he said.
“If the math is a wash or, you know, you’ve looked at your situation and it doesn’t make it clear, then it comes down to the mindset. What makes you feel better? Some people feel better with a lower mortgage balance. Some people feel better with a larger investment balance.”
From a holistic perspective, Sellery suggests that someone who wants to retire early might prioritize paying off the mortgage, while someone who intends to work part-time in retirement might prefer to have a larger investment portfolio.
Meanwhile, CSR Wealth’s Gasper says age and risk tolerance are factors in the decision-making process and that for young people in particular, there are three financial goals to achieve.
“If we’re talking to 30-somethings, then that’s a big factor. Increase your cash flow, pay as little interest as possible and invest for the long term.”
Michelle Zadikian is a Senior Reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.
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