Where you should put extra cash

Balancing a bank statement closeup with pencil and calculator

For households that have some extra cash left over at the end of each month, they could try to pay down their debt, mortgage, or increase their investment portfolio.

Borrowing rates have soared and the stock market has taken a slump this year, and some Canadians are wondering where to best put the extra money left over at the end of the month.

There’s no question that the rising cost of living has taken a toll on many household budgets, but those able to keep their spending down and maintain a positive cash flow may have to decide whether to invest those extra dollars in their consumer debt, mortgages or their investment portfolio.

Because everyone’s life situation is unique, a number of factors need to be considered before deciding which area to prioritize.

According to Bruce Sellery, personal finance expert and founder of Moolala, you can assess the health of your finances and identify gaps that need to be addressed by using the “priority pyramid.”

The pyramid of priorities, modeled after Maslow’s hierarchy of needs, is a hierarchy of financial fundamentals: having positive cash flow in your monthly budget, eliminating consumer debt, contributing to savings, optimizing tax benefits, investing, and ultimately optimizing investment returns.

“If they have credit card debt, they don’t have extra cash. They may think they have it. But they don’t,” Sellery said Yahoo Finance Canada in a phone interview.

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Before a person can throw extra money on a mortgage or investments, paying off credit card debt should be a priority, since many cards have an interest rate of around 20 percent.

Once the budgetary fundamentals are in place, like eliminating high-yield debt and setting up 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 choosing between making a lump sum payment on a mortgage or adding to an investment portfolio is whether the mortgage rate is fixed or variable, Frank Gasper, wealth advisor and founder of CSR Wealth Management, said over the phone.

As interest rates soared this year, homeowners who had previously opted for the hugely popular variable rate have seen a significantly higher amount of their monthly payment go towards interest. Many have seen their paybacks extended or their payments increased to offset the higher interest rate.

However, for a homeowner who has secured an ultra-low fixed interest rate of 2%, for example, Gasper says there is “no point” in paying off the mortgage if the investments offer a higher return.

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“If your risk tolerance allows, it’s a good idea to put money into the market,” he said. He added that even risk-averse investors can look for safer investments, such as guaranteed investment certificates (GICs), which currently offer yields of around 4.5 percent.

Fixed-rate homeowners may need to renew their mortgages in a higher-rate environment for years to come, which could be the tipping point for mortgage payments to suddenly become a wiser choice versus investing, Gasper adds.

Sandy Yong, a personal finance writer and author of The money masteralso says she prefers the investment option, although she emphasizes that everyone’s financial situation is different.

“I would choose to invest in the stock market because you just never know when the market will go down in double digits next,” she said over the phone.

“The market has been pretty much down all year and could it go further down? Yes of course. It could get a lot worse, but when you have this long-term mindset where you’re investing that money for the long-term, whether it’s for retirement or other long-term goals, it’s hard to pass up this opportunity.”

The S&P/TSX Composite Index is down about 16 percent from its peak earlier this year as higher interest rates and fears of a looming recession weigh on stocks.

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mindset money

Sometimes the best option can boil down to simple math, Moolala’s Sellery says, for example when investment returns significantly exceed the interest charged on the mortgage. However, with mortgage rates now hovering around 5 percent, the math is less clear.

“Nowadays mathematics is head to head. So it’s not about the math. In my opinion, it comes down to the mindset,” he said.

“When the math is a wash or you’ve looked at your circumstances and it doesn’t become clear, then it’s the mindset that counts. What makes you feel better? Some people feel better with a lower mortgage balance. Some people feel better with a larger investment balance.”

Taking a holistic view, Sellery suggests that someone looking to retire early should prioritize paying off their mortgage, while someone planning to work part-time during retirement might gravitate toward a larger investment portfolio.

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

“When we talk to 30-year-olds, that’s an important factor. Increase your cash flow, pay as little interest as possible. And invest for the long term.”

Michelle Zadikian is Senior Reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.

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