The many arguments you can find online about whether it’s best to pay down your mortgage or invest tend to gloss over the most important considerations. The answer isn’t in detailed calculations of returns based on assumptions that are just guesses. The truth is that if your income remains stable, you’ll do fine with either approach. The real answer comes when considering problem scenarios.
All investment choices should balance two needs: (1) capturing wonderful returns through good times, and (2) surviving bad times. If you just average out the good and bad times and project future returns based on some middle-of-the-road assumptions, you might be taking on too much risk.
One possible future for you is that you will always have a job when you want one and enjoy ever-increasing pay until you choose to retire. Here is another possible scenario:
– The stock market crashes and stays low for 5 years.
– Shortly after the crash, you lose your job.
– It takes you 6 months to find another job.
– The new job pays only two-thirds of your former salary.
– Your salary never recovers to its previous inflation-adjusted level.
If you knew this was a possibility for your future, would you pay off your mortgage or invest? When I was younger, my response to this possibility was to buy a less expensive house than banks told me I could afford, and I maintained emergency savings. By having a lower mortgage, I would still have been able to afford my mortgage payments on a lower salary. The emergency savings would have supported me during a period of unemployment.
What should people do now if they already have a large mortgage? Well, when you consider the negative scenario above, one good response is to build some emergency savings. Another good response is to pay off the mortgage aggressively until the principal is down low enough that a smaller salary could handle the payments. Once the mortgage principal is down, you can start building retirement savings.
Personally, I think it’s better to rent or buy a less expensive house from the start so you can begin to invest right away. But if you’re already stuck with a huge mortgage, you have to consider a safer path. This safer path may result in smaller future savings if the bad scenario never happens, but that’s no reason to ignore bad possibilities.
In the end, each person needs to find his or her own balance between surviving bad times and reaping returns during good times. But my experience has been that most people just deny that bad scenarios are even a real possibility for them.