is paying it off early. Imagine I say to you, ‘Want an investment that pays up to 80 times as much as cash in some bank accounts but is absolutely safe and totally secure? And what about a 100 per cent guaranteed return that can be higher than financial watchdogs allow any investment company to use for forecasting future profits?’ Sounds like a snake-oil salesman scam, doesn’t it? But if your first reaction is, ‘You’ve got to be kidding’, then you’re wrong. Paying off mortgage loans with spare cash offers an unbeatable combination of high returns and super safety.
To see what I mean, take a look at the following mathematics. In this particular example, I’ve used interest-only figures for simplicity, although anyone with a repayment (capital and interest) loan will also make big gains. And, again for simplicity, I’ve assumed that the interest sums are calculated just once a year. Six per cent is at the higher end of mortgage interest now. But it’s very possible that over the life of a mortgage six per cent will be at the low end. That said, here’s the scenario:
If you rent, always look at what it would cost each month to buy the same property – assuming you can find enough for a deposit. Purchasing incurs substantial costs, such as stamp duty and legal fees, so you have to factor those in if you can afford to buy, but don’t intend to hang around for long in any one place. Whichever – buying or renting – works best for you, putting aside any cash you save through your choice for the future is always a good idea.
Homes have generally been a good medium- to long-term investment. They’ve beaten inflation over most periods and more than kept up with rising incomes in most parts of the country.
Some areas have seen spectacular gains. But even in the worst parts of the country, you’d have been very unlucky to lose over the long run, even counting the big price falls of the early 1990s and, more recently, the collapse in values following the 2008 financial crisis.
Whether the next decade will see the spectacular gains of the first years of the century is impossible to say. But homes should continue to be a good investment and at the very least keep up with rising prices over time.
However, although your home is the essential roof over your head, never see it as a conventional investment, no matter how appealing any price rise may be. Buying and selling costs a fortune – legal fees, estate agent charges, removal vans, stamp duty – as well as taking up time and requiring saintly patience. You don’t need to own shares or bonds or hedge funds. But you do need somewhere to come home to.
Someone with a standard mortgage and with £100,000 outstanding at 6 per cent pays £60 a year, or £5 a month, in interest for each £1,000 borrowed. On the £100,000, that works out to £6,000 a year or £500 a month.
Now suppose that the homebuyer pays back £1,000. The new interest amount is £5,940 a year or £495 a month.
Compare the £60 a year saved with what the £1,000 would have earned in a bank or building society. The £1,000 could have earned as little as £1 at 0.10 per cent. And even at a much more generous 3 per cent, it would only make £30 – half the savings from mortgage repayment.
‘But you’ve forgotten income tax on the savings interest,’ you rightly say.
Ah, but the money you save by diverting cash to your mortgage account is tax-free. It must be grossed up (have the tax added back in) to give a fair contrast. Basic-rate taxpayers must earn the equivalent of 7.5 per cent from a normal investment to do as well. And 40 per cent taxpayers need a super-safe 10 per cent investment return from their cash to do as well.
Now where else can you find a 7.5 per cent a year guaranteed return, let alone a guaranteed 10 per cent a year? Nowhere.
Before investing for the longer term, you need to set up your own personal emergency (or rainy-day) fund for contingencies that you can – and, more importantly, can’t – imagine but couldn’t pay for out of your purse or wallet. The fund should contain enough money to pay for events such as a sudden trip abroad if you have close family in distant lands, any domestic problem that insurance wouldn’t cover, a major repair to a car over and above an insurance settlement or a substantial vet’s bill not covered by insurance.
Here are some additional snippets from experience for you to keep in mind:
✔ Don’t put your emergency-fund money in an account that offers a higher rate of interest in return for restricted access, such as not being able to get hold of your money for five years. The problems and penalties associated with getting your cash on short notice outweigh any extra-earning advantages.
✔ An emergency cash reserve serves as reassurance so you can more easily ride out investment bad times such as a fall in the value of shares.
✔ Monitor your potential emergency cash needs on a regular basis. They can shrink but are more likely to expand.
✔ Know that you may not be able to access some investments in an emergency. Don’t be put in a position where you’re forced to sell.
✔ Know that your credit card can be a temporary lifeline, giving you breathing space to reorganise longer-term investments when necessary. The key word here is ‘temporary’ – maybe up to three or four months. Using plastic for long-term borrowing is a certain road to financial ruin.
Chapter 3
Recognising What Makes an Investor Tick
In This Chapter
▶ Understanding components of investor psychology
▶ Looking at the standoff between greed and fear
▶ Investing as a casino wheel or sensible strategy
▶ Considering money-making routes for the cautious
Needlework and carpentry are among the skills where you need a firm hand and a good eye as well as technical ability. You need technical ability in investing too. But as well as a firm hand and a good eye, you need an understanding of investor psychology – how you tick and how the other investors who make up the market tick as well.
