Ask Paul: Should we prioritise ETFs or our mortgage?

Melissa and her husband know they could potentially earn higher returns putting their money in ETFs. But with two young children and a mortgage to pay off, is investing worth delaying the security of being debt-free?

Reader question

We'd really love your opinion on our plan to prioritise paying off our mortgage over the next four years, rather than putting more of our spare cash into ETFs.

We understand that, over the long term, investing in the sharemarket is likely to produce higher returns than the interest we save by paying down a 6% mortgage.

We're wondering whether there is value in treating mortgage freedom as the first stage of our overall wealth-building strategy.

I'm 35 and my husband is 36 years old. We have two children, almost five and two, and our priority at this stage is having flexibility and time with them.

My husband recently changed careers to a work-from-home role, which has given our family a much better lifestyle and more time together, although his income is temporarily lower while he completes training.

He earns about $85,000, but we expect this to increase to around $130,000 over the next couple of years.

I work flexible part-time hours from home earning about $50,000 per year, which also gives us a good balance with the children.

Our home is worth approximately $1.1 million and we owe $424,000 on the mortgage, with $110,000 sitting in our offset account.

Rather than making large additional repayments, our goal is to build the offset aggressively so we retain access to the money while effectively reducing the interest we pay.

We believe that, if we stay disciplined and direct our increasing income towards the mortgage, we could potentially have the loan fully offset/paid off within four years.

I have around $100,000 in my super and $150,000 in my husband's, and we also have $36,000 in ETFs.

Once the mortgage is gone, our plan would be to redirect that cashflow into super, ETFs and maybe an investment property in our 40s.

Are we being too risk-averse by prioritising mortgage freedom when the maths suggests investing could produce higher returns?

Or could paying off the mortgage first be a sensible foundation that gives us greater financial freedom and allows us to invest much more aggressively afterwards?

We'd love you to crunch the numbers and tell us what you would do in our position. - Melissa

Paul's response

Very good question, Melissa, but fortunately we don't need to crunch too many numbers to come to an answer.

You see, the answer is you and your husband.

The answer lies in your attitude to life, to risk, security, future career opportunities, your children and your lives together.

You have already told me a lot. Funnily enough the least important bit is your mortgage rate of some 6% and the potential long-term returns on a low-cost ETF.

Here we can quite easily crunch numbers, but let's be real.

Your mortgage rate is very real and no doubt moved up with the recent rate rise.

Obviously, it will go up with any future rate rises and down if we go into a recession, but the chance of seeing the Reserve Bank base rate of interest back near zero as we did a few years ago is not high.

Inflation is stubborn and governments globally seem to have forgotten that the whole idea of government is to run surplus budgets in strong economic times and deficit budgets in tough times.

We, of course, are strongly to blame for this.

Very sensibly our preference is lower tax and more services but, sadly, our politicians have long since realised that handing out freebies, like chocolates to children, is a strong incentive for us to vote for them.

So here we are as a strong nation, with record sales of resources to the world, and record taxes, and running deficit budgets, which has led to a near $1 trillion level of national debt and interest repayments in excess of what we spend on Medicare.

A good place to live

Anyway, the good news is that Australia remains one of the best countries on the planet to live, work and raise a family.

Not to mention a not perfect - but better than pretty much any other country - medical system, education system and the list goes on.

Mortgage vs ETFs

Back to your mortgage.

If you can pay it off in around four years, I think we can be reasonably confident you will be paying it off in a climate where mortgage rates are 6%-7%, plus or minus a percent.

With this strategy as you know, you are effectively earning the interest rate on your mortgage, risk free and tax free.

I agree strongly with adding savings to your offset account to give you future access to the money.

Next. What could you earn in an ETF? Here we have a lot of volatility.

Sure, the average return on shares, including dividends, has been about 10% pa over the past 140 years or so. But barely in any of these years do we earn 10%.

We've had years of more than 50% and in the Great Depression of the early 1930s, the market fell steeply in one year.

Given the average of around 10% has persisted for over a century, two world wars, a huge depression, banking collapses and Covid, maybe that is a realistic long-term average.

Even so, it is only about 3% above the interest rate of your mortgage and we have made no allowance for tax or any other costs.

Family time

Now we add in you and your family.

As I said, you have given me many clues, such as your husband retraining from home to give you more time together and a better family life.

The numbers say that historically you would be better off in the long run investing in ETFs, but with no certainty. The risk is higher.

In an uncertain world, as a young couple, with two young children and many years of work and investing ahead, based on both risk-adjusted numbers and your personal situation, in your shoes my wife, Vicki, and I would pay down the mortgage.

In particular if you can do this in four years then use this secure base to keep saving and investing.

I should disclose our bias.

We are conservative, so before we started investing, many moons ago, when we also had young children, we paid off the mortgage, then started building investments and super.

In Australia, as you know, a family home is bit like the golden goose.

It is an exempt asset for just about everything. Land tax and capital gains tax free - and if needed in later life, exempt for a future pension.

An even more golden goose is a goose with no debt.

Sure, you may make more money on crypto, speculative mining shares or buying lotto tickets, or you may lose a lot of money.

But a fully owned home is not just an extraordinary asset, it is more than that. You get to live in it as your home.

I'll leave it to you, but my vote is pay off your mortgage by adding to your offset account and then concentrate on growing assets outside of your home.

Get stories like this in our newsletters.