We’ve Paid off the Mortgage – What Now?

Paid off Mortgage - Now What?

Congratulations!! A paid off mortgage is an incredible achievement! 

Most have been so focused on achieving this goal, they are not sure what to do next.

With mortgage repayments gone, you will have a significant chunk of cash flow freed up.  

Most will keep their mortgage open whilst fully offset, for more flexibility to withdraw money in an emergency. 

If you just want the mortgage closed once and for all, Money magazine has an article on practical considerations of how to actually close your mortgage and obtain the deed certificate.

Whether you close the mortgage, or keep it open/fully offset, there are three main options for your new freed up cash-flow:

  1. Invest it to achieve financial goals
  2. Spend it on lifestyle upgrades
  3. Reduce working to free up time for other passions

The main issue is to make this decision consciously – don’t let it slip away from you through unconscious lifestyle inflation. 

Put this hard-earned cash to work for whatever you need and value the most. 

Let’s examine each option in more detail.

  1. Invest it to Achieve Financial Goals

Have you developed a financial plan?  

You need to know if you are on track for retirement.  To know this, you need to have set your goals. 

When would you like to retire?  What will your annual spending be? How much is your superannuation projected to pay out if you continue working as is until your desired retirement age?  If you desire to work less, how does this adjust this picture? 

What other important financial goals do you have over the next 20 years – a new car?  A wedding?  Kids’ education costs?  A trip to Antarctica (yes please!)?

Examine your financial goals and current trajectory to decide whether you need to put some or all of the freed-up cash towards reaching your goals.

What is your risk tolerance?  It’s important not to invest in a volatile asset if you’re likely to pull your cash out when the stock market crashes. 

We tend to overestimate our risk tolerance.  Were you invested in 2008?  How did you behave? What did you learn? 

If you have never been through a market correction, it’s probably best to play on the periphery while you get accustomed to volatility.  Perhaps try a micro-investment app whilst investing most of your cash in a lower volatility asset.

The worst thing you can do is pull your money out when the market is down, in my experience it takes experiencing a couple of market downturns to feel confident enough to ride it out.

What is your tax position?  Do you have a long-term no- or low-earning partner at home who could receive investment income without paying tax? 

Or are you a high income household for which tax minimization strategies are important?

You won’t want your money sitting in a bank account for more than a year (apart from your emergency fund) or it will shrink in real value due to inflation. 

Inflation is what makes the cost of living increase every year (usually 2.5-3%). 

$100 is worth less in terms of what it can by as the years go by.  Your investments need to beat inflation, or you are going backwards. 

Generally, higher rates of return are associated with higher risk. 

You can work out what % annual return you require to meet your goal using Money Smart’s savings calculator.  

You need to know how large a retirement sum you need (25 x annual spending is a reasonable starting point), and how much you will spend per year in retirement. 

You can then fiddle with the interest to work out what post tax, inflation adjusted return you require.

It makes little sense to take on more risk with your investments than you need to achieve your goals.

What is your time frame?  Whether you are 35 or 55 makes a huge difference to the amount of risk you want to take on. 

Real estate generally needs at least 10 years to be worthwhile, 7 years is often quoted as the minimum time-frame for the stock market. 

Your health and life expectancy are big factors in how long you need your retirement nest egg to support you (and therefore your withdrawal rate).

should i make a financial plan?

If you decide you need or want to invest, you have two main options:

a). Dollar cost average into an investment

The easiest and lowest risk option is to simply divert your freed up cash-flow into an investment. 

Make this automatic with a direct debit and be patient, you will soon be surprised how quickly it adds up. 

Now is the time to do some research – if you don’t yet know where you want to put your money, direct debit it into a savings account and get started with some research and professional advice

There are many options in investments to choose from:

Cash in the bank is government guaranteed, up to $250,000, even if the bank goes bust. 

But you will receive less than 2% interest, which is unlikely to keep up with the pace of inflation (2.5-3% per year). 

Term deposits are currently providing equally feeble returns.  Unless you already have more money than you need for your goals, this is not a realistic option for more than an emergency fund and retirement cash reserve.

Bonds – Government bonds are the lowest risk investment. 

By paying into a bond, you are lending money to the government, who are considered extremely unlikely to default. 

As interest rates drop, bond “Coupon rates” (interest you earn for money loaned) increase, making them more attractive to investors. 

Normally, the longer term bonds attract a higher yield, but over recent months this has reversed so that short term bonds are paying out more (this is apparently supposed to predict a stock market crash, but it’s been happening for a while…) 

You need a really large investment amount to buy bonds directly, but Bond ETFs can be easily brought via a broker on the ASX, similar to shares. 

Corporate bonds – Have more risk than government bonds, but are still considered low risk.  This time you are lending your money to corporations who pay you interest (the yield).

Insurance bonds – These are nothing to do with the bonds above.  They are investment products offered by insurance companies and can contain any type of investments.

If investments are held for 10 years, there is a tax benefit to top tax threshold households, as tax is only paid at 30% on these investments. 

Examine the fee structure carefully to ensure the fees don’t consume all the tax benefit. 

Peer to Peer lending – This is another, fairly recent way to lend your money, directly to other consumers. 

Peer to peer lending connects investors with borrowers, cutting out the middleman so giving both a better deal. 

They offer decent rates, especially over 5 years, but the risk of borrowers defaulting is the main issue. 

Rate Setter have a provision fund that pays in cases of borrower default, but if there was a huge number of defaults, this would be overwhelmed and investors would lose their money. 

Money shouldn’t be invested that can’t be lost, but P2P lending may have a peripheral role in a portfolio (I’ve not invested yet).

Shares – The easiest way to gain exposure to Australian and International equities is through ETFs or index funds. 

Buy the whole market initially (broad Australian and International index fund or ETF), and once you have a reasonable portfolio, decide whether you want to be bothered researching individual shares. 

Share markets crash, and rebound, and bounce around all the time. 

History tells us dollar cost averaging into a broad index fund is the best way to go most of the time.  It’s hard to beat, but you have to stomach the volatility.

The ASX has a basic education online course for beginners . 

To buy shares, ETFs, or bonds, you will need a broker.  Google “Broker” and you will find lots of choice.  Look at price (particularly for the size of trades you are likely to make), and education/information provided.

Most people use a discount online broker, although full service brokers still exist.  These offer advice on investments.

Property – The only way to dollar cost average into property is via a Real Estate Investment Vehicle (A-REIT) or BrickX

There are variable amounts of leverage with these funds, and they do have the advantage of diversifying your investment over multiple properties and mean no landlord hassles. 

A-REITs also have the advantage of more liquidity than a direct property investment which you have to wait to be sold.

There are residential and commercial real estate trusts, allowing individuals to dip their toes in the commercial property market, which is often considered higher risk to buy a single asset in and may be financially out of reach for many investors.

b). Borrowing to Invest

If you have an appropriate time frame and are willing to take extra risk, leverage can increase returns. 

The equity in your home can be used to borrow funds for an investment property, or for those with knowledge and experience, shares.

Leverage is a double-edged sword in my humble opinion.  It can magnify returns but makes it possible to lose more than the money you have put in, and in extreme circumstances can threaten the home you have worked so hard to pay off. 

Leverage needs to be considered carefully, first minimizing risks. 

2. Upgrade your lifestyle

If you have already hit all your financial goals, are on track for retirement, have an accessible healthy emergency fund and are happy in your work, perhaps it’s time to upgrade your lifestyle. 

Or perhaps you’re putting some money towards investments but feel you can afford to treat yourself a little. 

Consider carefully before committing to ongoing regular costs and ensure they are really worth your time earning them. 

Take some time to consider what will really produce the best benefit to your lifestyle. 

In the words of Paula Pant, “You can Afford anything, but not everything”.  I don’t think most doctors believe this applies to them.  It applies to everyone!

Spend some time thinking about what will really improve your quality of life, instead of impulsive purchases. 

Experiences seem to produce more ongoing pleasure than products, especially if planned in advance and anticipation and delayed gratification are involved.

My personal priorities would be 1). Increase holiday budget and plan an AMAZING trip every year 2). Take time off at half pay so that I can take more time off during school holidays to spend with my little ones 3).  Getting a cleaner so I don’t have to spend my precious time off doing boring housework.  Everyone’s different though!

 

3. Reduce working to free up time for other passions

Perhaps the best improvement in lifestyle would be to work less.  Part-time work is an amazing opportunity, in my opinion, to live a more balanced life. 

With more time to enjoy with my family, and indulging hobbies, when I return to work I am more refreshed and able to enjoy work more.  I appreciate the benefits of more time to look after my health with regular exercise and healthy meal planning and preparation. 

Consider if part-time work would improve your lifestyle.  Once in the top tax bracket, cutting hours has a disproportionally minor effect on pay due to high taxation as you get paid more. See more about optimizing your income for tax.

If you are unable to cut your hours permanently, perhaps you could take some more time off unpaid (for the self employed) or on half pay to allow longer holidays. 

No matter what you choose to do with your freed up cash flow, this is an exciting time of life, with a plethora of opportunities to choose from. 

Enjoy your debt free (or non-deductible debt free!) life and the freedom that comes with that financial security of completely owning your own home.

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