If you’re looking for a financial adviser, one of the best places to start is Mary Holm’s list of financial advisers. She doesn’t endorse these advisers, but they meet minimum criteria that mean their interests are more aligned with clients’ interests than many others.
On her site, Holm provides a good way to test an AFA:
A good adviser – who is putting your interests first – should always ask every client at the start if they have debt. If yes, and the interest is higher than mortgage rates, the adviser should recommend repaying that before doing any investing.
I think this is a sound rule of thumb.
(Interestingly, although this advice is in the best interests of clients, it isn’t in the best interests of many advisers. Most advisers charge their clients as a percentage of their investment portfolio. If they charge a standard advice fee of 1% and a client has a windfall of $400,000, for instance, they stand to gain annual fees of $4,000 per year by getting the client to invest in financial assets. They gain far less by getting the client to repay their mortgage. But I digress.)
Where clients have high interest debt like credit card debt or vehicle finance debt, I recommend paying that off as a priority. For whatever reason, however, I don’t tend to attract clients with a lot of debt. I’ll leave them to Dave Ramsay (who is a terrific guru if you want to pay off debt, but a terrible guru if you don’t have debt. But I digress again).
For clients who have a mortgage, however, it’s worth expanding on Mary’s comments.
If a client has a mortgage, I’ll usually urge them to repay it as soon as possible. Repaying your mortgage a year or two earlier than you otherwise would can have a profound impact on your long-term financial outcomes. Repaying debt has the same effect on your net worth as investing – you’re still building wealth. Assuming you’re not penalised for making additional repayments, you’re getting a guaranteed, tax-free, risk-free return. To get a better return you usually have to take on quite a bit of extra risk.
Having said that, I quite often recommend that clients put some of their excess income into investments rather than repaying the mortgage.
There are a few reasons for this:
- By investing in financial assets, they can accumulate some relatively liquid assets, in case something unexpected happens. Many people have mortgage offset accounts that they can draw on, but at least psychologically it’s nice to draw down on assets you have rather than drawing down more debt. (Even if the effect on your net worth is technically the same! Remember, I advise people, not Vulcans.)
- It gives clients the experience of investing and being exposed to financial assets such as shares. For many people, having funds in KiwiSaver is the extent of their investment experience. The trouble is, having investments locked away in KiwiSaver that you can’t access until you’re in your sixties doesn’t give you the same feeling as investing in assets that you can access and invest or spend in any way, at any time. I can try to work out what a client’s psychological tolerance for risk is by talking about various hypothetical scenarios, but the only way of knowing how someone will stomach the ups and downs of being invested in shares is through experience. As the saying goes, you can explain sex to a virgin, but you’ll never capture the experience. As a rule, the earlier that someone can get that experience, the better. It’s generally better to get that experience when you only have a relatively small amount at stake, rather than several hundred thousands of dollars all of a sudden – for example, because of the sale of a house, a windfall such as an inheritance, or getting access to KiwiSaver funds at the same time as being entitled to NZ Super.
- For a small proportion of people, their risk profile is such that it’s worth taking on the extra risk to generate a superior return to their mortgage rate. People borrow money to buy property all the time, and property is illiquid and undiversified, and historically hasn’t necessarily generated better returns than shares (especially after factoring out the effect of leveraging by borrowing). Putting the money that could have gone towards repaying the mortgage on investments such as shares is pretty similar to borrowing money to buy shares. It’s not for most people, but it’s appropriate for some.
I agree wholeheartedly with Mary Holm’s comment. For the majority of people, the smartest thing they can do is repay debt. That includes paying off the mortgage ASAP. (Subject to not being penalised by the lender for doing so.) However, for a good portion of clients, it’s also appropriate to supplement additional mortgage repayments with some investments.
Of the three reasons I gave above, the main reason I recommend this to clients is to give them the experience of investing.
Ultimately, repaying the mortgage might get them a better return in dollar terms in the short term. But the experience of investing – that’s an education, and it will often put them in good stead in the future. If they’ve experienced market volatility with $10,000 in shares, it will season them for the future, and position them to make better decisions when they’ve got $400,000 to invest and the stakes are higher.
- Repaying debt is building wealth
- A 30 year mortgage is too long
- The absurdity of asset-based fees
- Fairhaven Wealth’s competitive advantage (or: Why I don’t charge asset-based fees or commission)
- Headwinds and tailwinds: Every dollar is easier than the next
- What is your investing risk profile? Answering a risk questionnaire won’t tell you.