Mortgage, debt, investing: Where you should put extra cash

Balancing a bank statement close-up with pencil and calculator
For households that have some extra cash left over at the end of each month, they might look at paying down debt, their mortgage or bolstering their investment portfolio.

Borrowing rates have skyrocketed and the stock market has taken a downturn this year, and it's leaving some Canadians wondering where is the best place to allocate any extra money left over at the end of the month.

There's no question the soaring cost of living has severely strained many household budgets, but those able to keep their expenses low and maintain a positive cash flow might be having to decide between putting those extra dollars towards their consumer debt, mortgage or their investment portfolio.

Since everyone's life situation is unique, there are a number of factors to consider before deciding which area to prioritize.

One way to gauge the health of your finances and identify gaps that need addressing is by using the "priority pyramid," according to Bruce Sellery, a personal finance expert and founder of Moolala.

Modelled after Maslow's hierarchy of needs, the priority pyramid is a hierarchy of financial fundamentals: Having a positive cash flow in your monthly budget, eliminating consumer debt, contributing to savings, optimizing tax advantages, investing and finally, optimizing investment returns.

"If they have credit card debt, they do not have extra cash. They may think they do. But they don't," Sellery told Yahoo Finance Canada in a phone interview.

Before an individual can put extra money towards a mortgage or investments, he says, paying off credit card debt should be the priority since many cards have an interest rate of around 20 per cent.

Once the budgeting basics are in place, such as eliminating high-interest debt and establishing an emergency fund, Canadians can "earn the right to move up the pyramid," he says.

Mortgage vs investing

One of the factors to consider when faced with the choice between lump sum payments on a mortgage or bolstering an investment portfolio is whether the mortgage rate is fixed or variable, Frank Gasper, a wealth advisor and founder of CSR Wealth Management, said via phone.

As interest rates skyrocketed this year, homeowners who had previously chosen the wildly-popular variable rate have seen a substantially higher amount of their monthly payment go towards interest. Many have seen their amortizations lengthened or their payments increased to account for the higher interest rate.

However, for a homeowner that was able to lock in an ultra-low fixed rate of two per cent, for example, Gasper says it "makes no sense" to pay down the mortgage when investments are offering a higher return.

"If their risk tolerance allows for it, it is a good idea to start putting money into the market," he said. He added that even risk-averse investors can look into safer assets such as guaranteed investment certificates (GICs) that are currently offering returns of roughly 4.5 per cent.

Homeowners with a fixed rate might have to renew their mortgage in a higher interest rate environment in the coming years though, which could tip the scales to make lump sum mortgage payments the wiser choice compared to investing, Gasper adds.

Sandy Yong, a personal finance writer and author of The Money Master, also says she prefers the investing option, though she emphasizes that all financial situations are different.

"I would choose investing in the stock market because you just never know when the next time will be where the market goes down double digits," she said via phone.

"The market has been pretty down all year and could it go further down? Yeah, of course. It could get much worse but if you have that long-term mindset where you're investing this money for the long term, whether it's for retirement or other long-term goals, then it's hard to pass up on this opportunity."

The S&P/TSX Composite Index is down roughly 16 per cent from its peak earlier this year as higher rates and concerns about a looming recession hammer stocks.

Money mindset

Sometimes, the best option can come down to simple math, Moolala's Sellery says, such as when investment returns clearly outpace interest charged on the mortgage. However, with mortgage rates now hovering around five per cent, the math is less clear.

"These days, the math is neck and neck. So it doesn't come down to math. It comes down to mindset, in my opinion," he said.

"If the math is a wash or, you know, you've looked at your circumstances and it doesn't make it clear, then it comes down to mindset. Which makes you feel better? Some people feel better with a lower mortgage balance. Some people feel better with a bigger investment balance."

When taking a holistic view, Sellery suggests someone who wants to retire early might prioritize paying off the mortgage, whereas someone who intends to work part-time during retirement might lean towards having a bigger investment portfolio.

Meanwhile, CSR Wealth's Gasper says age and risk tolerance factor into the decision-making process and that for young people especially, there are three financial goals to strive for.

"If we're talking to 30-somethings, then that's an important factor. Get your cash flow up, pay as little interest as possible and invest for the long term."

Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.

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