Transcript

Hi, Everyone. Welcome to the Wiser Financial Advisor with Josh Nelson, where we get real, we get honest, and we get clear about the financial world and your money.      

This is Josh Nelson, Certified Financial Planner and founder and CEO of Keystone Financial Services. We love feedback and we’d love it if you would pass it on to me directly at josh@keystonefinancial.com . Also, please stay plugged in with us and get updates on episodes and help us promote the podcast. You can subscribe to us at Apple podcasts, Google, Spotify, or your favorite podcast service. Let the financial fun begin!

I’m glad to be back. We had a great summer and got to enjoy a lot of time outdoors here in Colorado as well as getting the opportunity back in the Midwest to see family we hadn’t seen for a while.

While we were away, a lot of you got to enjoy our “Best of” episodes and I highly recommend you go back and listen to those if you didn’t get a chance. We think those are the most impactful episodes that would make the biggest difference in people’s financial lives. And that’s really why the Wiser Financial Advisor exists.

In the Book of Proverbs, it specifically says that seeking after wisdom is the wisest thing that we can do, and it’s said that the Book of Proverbs was written by Solomon, the wisest person who ever lived. So I’m going to go with Solomon and think that this is a good idea. What we’re doing is going back and looking at people who have walked before us, trying to find those time-tested principles that will make our financial lives better.

Today, we’re going to talk about one of my favorite financial questions that comes up: “Should I invest or should I pay off the mortgage early?”

Before we get into this, I do want to tell you that this is one of my favorites simply because it’s a great quality question. It probably means that people are in pretty good financial shape, if they are asking this question. It means they’ve got some extra money someplace, either in their budget or they’ve got a lump sum of money that they can either be putting down on the mortgage or investing.

Now, before we get into this, I want to make sure to set the stage and lay down some assumptions. I am going to assume if you’re asking this question, that you already have a cash reserve, an emergency fund. We always recommend you keep a minimum of three to six months’ worth of living expenses in cash, just because stuff is going to happen. There are going to be emergencies and unexpected expenses. The reason for an emergency fund is to cover that so you don’t have to go out and borrow the money or have to cash out investments. Now, could there be emergencies that are beyond three to six months? Of course there could be, but in my experience, that will generally cover most emergencies or short term expenses that could come up.

Another assumption I’ll have is that all of your consumer debt is paid off. This includes credit cards, student loans, car loans, any other kind of debt that you might have besides the mortgage. We’ll assume that’s already paid off at this point. You want to have paid all that stuff off, regardless of interest rate, just so you don’t have consumer debt. Also, we’re going to assume that you’re properly insured. And of course, there are all kinds of insurance, but we’re going to assume that you have medical insurance and life insurance and car insurance, all the basic insurances that you would need to protect against major bad stuff happening.

Then finally, we’re going to assume that you’re already investing somewhere between 15 to 20% of your income for the future. I’m being generic with the word future, because your future is up to you. You could be thinking about this as college education for your kids; it could be you are saving for financial freedom which some people would call retirement; and it could be that you’re saving for other goals such as buying a piece of real estate or a cabin in the mountains. You have your own financial future. We love to get involved in that, of course, because we love to be able to help people achieve their dreams.

Anyway, we’re going to assume that all those things are already happening—and now you’re trying to figure out what to do with the extra money you’ve got. You’re thinking, “I could either be putting that money into the mortgage or investing it.”

My bias going into this, just so you know, is that I like to get debt paid off quickly. Clearly, there are situations where you’ve got to borrow money, especially for a house. Most people cannot just write a check and buy a house, so there are certain kinds of debt that are just kind of necessary evils, but we can pay that stuff off early if we want to and are able to.

One question to think about is: Where did that extra money come from? Is it extra in your budget because you paid off other debts? Good for you. That’s great because now you’ve got that extra cash flow to make this decision on. Or is this money that came from a lump sum? Did you receive this from an inheritance? Or maybe it was a gift from a parent or a grandparent. Maybe this money came from a bonus from your company, or maybe selling a company. Maybe you sold company stock that just got to be too much in your portfolio and now you’ve got to figure out what to do with the proceeds.

One principle that I always follow is that it’s generally not a good idea to borrow to invest. But we’re not talking about borrowing more money, we’re talking about: “Do I pay off debt?” One way to think about it is this: If your mortgage was paid off or paid down, would you take out an additional mortgage and invest that money in the stock market or any other kind of investment? My guess is you’re probably saying, “Heck no, I wouldn’t do that, that’s crazy.” I would agree with you, so it’s important to be asking: Why would you then not be paying down debt with extra money that you’ve got?

I’m a big fan of paying off debt. My bias comes from my dad. My dad was kind of a debt hawk early on in my life. He was always telling us, “You don’t want to borrow money unless you have to, and if you have to borrow money, you want to pay stuff off as early as possible.” And he always did. He liked to accumulate money and pay for a car in cash if he could. Even the mortgage he took out on our home, he paid off way faster than he would have had to. There were a few different factors that he learned, and we’ll talk about those now.

There are three primary reasons why I like to have people pay off their stuff early.

Number one, the non-financial reason behind this is peace of mind. There’s a certain sleep-at-night factor! I’ve been doing this for over 20 years now in my career as a Financial Advisor, and I can tell you that for people who have paid stuff off, especially a mortgage, I have yet to have somebody come back to me afterward and say, “That was stupid; I wish I hadn’t paid off my debt; I wish I had taken that money and invested it.”

Instead, there is a certain weight that comes off people’s shoulders when they get things paid off. I feel that same way myself when I’ve paid stuff off, especially making extra payments on my mortgage. It just feels good, and when my wife and I make that final payment on our mortgage, that will be something worth celebrating. We will sleep better at night, just because it feels good.

Number two reason to pay off the mortgage is financial security. You have lower fixed expenses when you don’t have debt payments. As you pay each thing off (and we’ve talked about this on the Debt Snowball episode) you’ve now increased your cash flow because you have lower fixed expenses per month. We can get by on a lot less money if we have to when we don’t have debt payments. So when the mortgage is there, you’ve got higher fixed expenses. Then when bad stuff happens—and it will, right? People lose jobs; people have health crises; people experience recessions. There are all kinds of bad things that will end up happening throughout your life, unfortunately, because that’s just the experience of life. But if you’ve got a greater amount of financial security—meaning less debt or no debt, then you’ve got lower fixed expenses. You’ve got the ability to weather those financial storms much better than somebody who’s got a bunch of debt.

One example of what I’m talking about is that in the spring of 2020 as the pandemic hit, a lot of people were financially rocked. They were seeing their portfolios go down by 20, 30, 40% depending on what they were invested in. A lot of people were losing jobs. A lot of people were losing businesses. People had rental properties where their tenants weren’t making payments and that might have been their retirement income. Many people were financially stressed during that time. But our clients that didn’t have debt or had very little debt were breathing easier. In fact, many of them were calling us up and saying, “You know what, I want to invest additional money right now because the market’s cheap, investments are cheap. I want to buy when things are low.”

Or let’s say they were already retired and taking money out of their investments. Some of those clients contacted us and said, “We don’t need that money right now. Let’s stop taking money out. Stop sending money from our portfolio or reduce the amount of money you’re sending from our portfolio. We just don’t need it right now. We’re not doing anything; we’re not traveling, and our debts are paid off, so we really don’t need as much money per month.”

So the financial security aspect of this shows how important it is to get stuff paid off, simply because it does put us in a more stable position.

Number three reason to pay off the mortgage is increased cash flow. Increased cash flow means that now we have extra money that could be invested. So it isn’t that there’s never a point of investing money, but it’s a cash flow perspective. It’s paying that debt off early because now we’ve got that extra payment each month that we can be putting back into investments that we choose and that fit with our portfolio.

Something to think about: Once the mortgage is paid off, you can take that extra money you have and start investing it. And of course I can go through all kinds of different financial scenarios. You probably could make the case either way here as far as where you would end up making the most money on your investments by doing it in a lump sum or doing it monthly.

The trick is, we have no idea when the next recession is. So if you were to take this extra lump sum of money and invest it, how do you know the market is not going to go down by 20 or 30 or 40%? We can hit a recession in a very short period of time. You don’t know when, and neither do I, and neither does the Fed Chairman or the President. Nobody knows in the future what’s going to happen, so there is a certain risk factor there.

One advantage that you’ve got with dollar cost averaging, which means a monthly investment instead of just arbitrarily picking a day and investing, is that you’re able to smooth those out over time, because sometimes you’re buying low, sometimes you’re buying high, and it’s kind of smoothing itself out. It can be a lower risk way of investing. You’re not just taking lump sums and throwing them in on arbitrary days, because especially if it’s a really big chunk of money that can be fairly risky to invest all at one time. If that was all your money, it could be a really bad time to end up doing that if you still have a lot of debt.

So there are really those three reasons: the non-financial peace of mind factor, the financial security you gain by paying stuff off, and the increased cash flow that can now be invested and later on end up making you a lot of money.

In building up your portfolio, let’s say you’re insisting: “Nope, nope, nope, I’m not going to pay down my debt.” Well, whatever you’re thinking about investing, is it a guaranteed investment? Think very carefully about the amount of risk that you’re taking once you leave the bank and take your money out of a savings account, checking account or CD. (Aand I get it, those things are all paying close to zero interest right now, but at least they are guaranteed to pay that, right? You know they are guaranteed to pay that and not lose principle.)

You want to be paying attention to how much risk you’re taking now that you’re leaving the bank and working with investing someplace else. Nothing is guaranteed. Real estate is not guaranteed. Stocks aren’t guaranteed. Bonds aren’t really guaranteed because there are risks with those too. So it’s important to think about all the different places that you might invest outside of the bank. There’s going to be some risk there. And how will you feel if you invest that money and it goes down in value even temporarily?

We need to be thinking about where did that money come from? Let’s say the money came from you selling a bunch of company stock. And maybe your purpose behind selling the company stock was not that you didn’t want it to grow. Maybe your perspective was: “This is part of my portfolio. I want it to grow, I just don’t want so much risk by having it all in this one stock from my company.” So that would be one instance where we might want to scratch our heads and think about it. Does it make sense to reinvest those dollars and put them back into the stock market but just do it in a much more diversified way? You probably could convince me on that circumstance; I could buy that argument.

But if it’s coming from a lump sum, let’s say from an inheritance or a gift or something else, and you still have debt hanging out there, how are you going to feel if that sum goes way down in value after you invest it? Is it really worth it?

There are a lot of emotional aspects when it comes to money. I firmly believe that 80% of financial success is psychology and 20% of it is the tactics. I know that sounds a little crazy because we’re conditioned to be looking at trying to get the best rate of return and get all the information. However, so much of people’s financial success does come down to psychology and the decisions they make based off their emotions.

So be thinking about all these factors when it comes to what you’re going to do.

And of course it helps to have a Financial Planner that can run some numbers and can give you a different perspective than what you might be thinking, whether with a lump sum or maybe a monthly amount that you’ve got. Remember those principles I went through before: we want to already be investing 15 to 20% before thinking about a mortgage paydown. If you’ve got extra money in your budget, yeah, I do recommend you pay off that mortgage early simply because of all the factors we just talked about. There are definite reasons financially, and definite reasons non-financially with the way it makes us feel to have debt or to pay it off.

I hope that’s helpful for today. If you have any particular questions, of course, please reach out to us because this is very individual. As you can imagine, it really does depend on the situation as far as what people do with their money. And there are tax implications and other implications depending on what kinds of debt you’ve got, what your income is, and how stable that is. That’s why the Financial Advisor’s favorite answer to questions is, “Well, it depends.”

It does depend on the situation, of course, and we want to make sure that on this podcast we are your financial advocate.

As time goes on, please pass this on to anybody that you think would find it interesting and helpful in their financial life. Again, hit subscribe on the podcast to make sure that you’re staying up to date with what we’re doing, and also to help promote this show. Thank you for listening to this show and helping us be successful with that.

God bless and have a great week.

The opinions voiced in this episode of the Wiser Financial Advisor with host Josh Nelson are for general information only and not intended to provide specific advice or recommendations for any individual. Investment advisory services offered through Keystone Financial Services, an SEC Registered Investment Advisor.