# Paying off the mortgage versus investing more

For Your Money

Let's do a little investment simulation. Don't worry - I'll do the maths.

Nomusa has a R5,000 personal loan and a R20,000 share portfolio. Her net worth is R15,000 (R20,000 share portfolio minus the personal loan).

If the stock market goes up by 10%, Nomusa makes R2,000 (R20,000 multiply by 10%) and her net worth goes up to R17,000 (R22,000 in the portfolio, minus the R5,000 loan). If the market goes down 10%, she loses R2,000.

Are you with me so far?

Nomusa decides to pay off the loan. Her net worth is still R15,000, but now it's R15,000 in shares and no debt. Then the stock market goes down 10%, and Nomusa only loses R1,500.

By paying off the loan, Nomusa's portfolio got less risky: The same change in the market caused a smaller change in her portfolio, even though her net worth stayed the same.

It doesn't matter that Nomusa borrowed the money for a dining room set. For as long as she owes the money, she's taking on more investment risk than if she didn't. Her net worth fluctuates more with each day's share portfolio returns because of the debt.

This is all grade school maths, right? But if we replace "personal loan" with "mortgage", it makes otherwise intelligent people, investors and financial planners alike, forget basic arithmetic.

Investing on mortgage

If you have both a mortgage and an investment portfolio, you're probably making a big mistake.

Let's go back to Nomusa. Now she has a R100,000 mortgage, a R100,000 house, and a R200,000 share portfolio. Her net worth is R200,000 (the portfolio plus the house, minus the mortgage).

When the stock market goes up 10%, Nomusa makes R20,000. When it goes down 10%, she loses R20,000.

Say she takes R100,000 from her portfolio and pays off the house. Her net worth is still R200,000, but her portfolio has dropped to R100,000.

Now when the stock market goes down 10%, Nomusa loses only R10,000. Her portfolio got less risky, but her net worth stayed the same. (Yes, we're assuming remarkable stability in the property market.)

Nomusa would tell you that she wasn't borrowing money to invest in shares, she was borrowing money to buy a house.

Well, her portfolio and her bank don't care to know this information. For as long as she owes money, her investment performance has a bigger effect on her net worth than if she didn't owe.

Should she pay off her mortgage early or continue to invest?

You will inevitably confront this question in your pursuit of financial security. The problem is the answer is far more complex and confusing than generally understood.

The intuitive response is to get out of debt. We all want the security of owning our castle free and clear with one less expense to deal with.

The prospect of making monthly payments for the next 30 years is hostile to freedom. However, there are times when intuition and finance disagree.

*Nkomo is a director at Inkunzi Wealth Group

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