What would you do with a little extra space in your monthly budget? Save for the dream car, splurge on your favourite restaurant or go on frequent shopping sprees to keep your seasonal wardrobe current? That all sounds fun, but you could also make this surplus work harder for your long-term financial well-being by investing it in your mortgage or super. Which of those options is best? Well, that depends on your age, income and priorities.
At First Financial, we actively listen to your long-term objectives and integrate your personal circumstances to empower you in making informed investment decisions. While determining the optimal choice between allocating your extra funds towards mortgage or super depends on various factors, here is a scenario that illustrates the potential gains and discusses the associated risks.
Mortgage vs Superannuation
Before delving into the numbers, it’s important to note that paying off your mortgage provides a risk-free return. With a known interest rate, distributing your extra funds to your mortgage ensures a guaranteed return on your investment.
Superannuation and other investments are typically regarded as riskier choices. This is because they expose you to market fluctuations, such as those in property or stock markets, where returns are unpredictable and not guaranteed.
When opting for investments like superannuation, the objective is often to attain better returns than alternatives. However, this necessitates being comfortable with potential risks and maintaining a strong tolerance for them.
The numbers for paying your mortgage
Let’s say you have an annual income of $85,000, and you have $200 per month remaining in your budget to do something financially beneficial. Your mortgage is at 6% interest, and as it’s your primary residence, interest on your mortgage is not tax deductible.
To determine the savings generated by putting this $200 monthly surplus into your mortgage, we simply multiply it by the interest rate, resulting in a savings of $12 in interest per annum. Not only does the extra repayment expedite loan repayment, but it also reduces interest expenses, thereby further shortening the mortgage duration.
In this situation, we’ll assume that no other funds are being invested in alternative options until the mortgage is repaid in full. Therefore, the primary benefit here is the significant savings in interest.
The numbers for contributing your funds to super
Now, let’s look at the numbers for superannuation, which can be a bit complex due to tax implications. The $200 you have set aside is an after-tax amount, while the mortgage interest rate of 6% represents an after-tax return. For this example, let’s use Australian Super’s balanced fund, which has averaged an 8.6% return over the last 10 years, pre-tax. Assuming a worst-case scenario of a 15% annual tax on the super fund’s earnings, this results in a net return of 7.31%.
You can choose to salary sacrifice your $200 into superannuation, meaning your money enters your fund pre-tax. With an income of $85,000, your marginal tax rate is 32.5%, plus an additional 2% for the Medicare levy. Let’s calculate how much of that $200 is now available to put into superannuation. The calculation is as follows: your $200 divided by one minus your tax rate (marginal tax rate plus Medicare Levy).
It works out at $305 a month that you have pre-tax to invest in your super, where the contribution will be taxed within the fund at 15%, leaving you with $259. If this $259 in the super fund earns an after-tax return of 7.31%, you’ll earn $18.95 on every $259 contribution you make.
Remember, it’s not all about the numbers
From a purely monetary standpoint, using the numbers in the above scenario, you’ll likely experience a larger return for your additional funds by investing them in superannuation and waiting out the duration of your mortgage. Eventually, you may even be able to utilise a lump sum from your super to pay off the mortgage, among other financial strategies.
However, the superannuation strategy carries more risk. Returns from super are not guaranteed, unlike paying off your mortgage, which offers a risk-free return. Sometimes, the option with the highest potential returns may not be the right one for your personal or family situation.
The other major consideration is money contributed to super often isn’t accessible until you turn 60. On the other had additional loan repayments are often accessible via the redraw function on our mortgage. So you need to consider how likely you may be to need that money in an emergency.
Risk tolerance varies among individuals when it comes to investing. Some people are naturally more comfortable with riskier situations, while others prefer safer, more conservative approaches. Understanding your risk tolerance is crucial for making informed investment decisions that align with your financial goals.
Talk to the wealth experts
If you have surplus funds each month to invest in your long-term financial security, there are various options available. We’re here to assist you in navigating these choices, ensuring you make the best decisions for your financial future.
At First Financial, our experienced financial advisers can help. They will listen to understand your goals and objectives and then make appropriate recommendations. Our goal is to help you retire life ready.
Contact us to get started on the pathway to wealth today.
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