Portfolio management

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2. Should you invest before paying off your mortgage?

It is often argued that you should not consider investing in shares until you have paid off all your debts, including your mortgage.

The argument is certainly valid for debts other than your mortgage. Over the very long term, the average return on UK stocks has been about 8%. If you take out virtually any type of non-mortgage loan or credit financing, you will most likely be paying a much higher annual percentage rate than that. So investing with cash from those sources is like robbing Peter to pay Paul.

This is particularly true of the rates on credit cards, which tend to be far higher than those on other forms of borrowing. That is why you should never under any circumstances finance share purchases with credit cards.

As for paying off mortgage debt, the argument is more finely balanced. There are certainly more reasons to do it than there used to be:

• Mortgage relief has been abolished, so the government no longer subsidises your debt.
• Inflation has fallen dramatically since 1981, and this has made mortgages a much heavier burden in real terms. Remember you pay your mortgage out of taxed income. That means a 7% rate is the equivalent of nearly 10% for earners in the top tax bracket.

On the other hand, there is still a case to be made for running a mortgage alongside your investments. Since this represents the cheapest form of borrowing available, it may be possible for you to average an investment return a few percent higher than the rate of interest you pay your mortgage lender.

Two serious caveats apply, however:

1. It is self-defeating to run a mortgage alongside your investments if you are trying to follow a medium to low-risk investment strategy. Your returns will probably be several percent below your mortgage rate.
2. Never, ever take out a new mortgage to buy shares.

A mortgage is a long-term commitment, whereas interest rates can move at any time. If you invest the cash and rates suddenly rise sharply, the value of your shares will collapse, while the cost of your mortgage will shoot up. That could prove ruinous.

But for younger investors, there are good psychological and financial arguments for starting a portfolio as soon as they have reduced their mortgage to manageable proportions.

• Investment is a skill that takes many years to learn. Starting early helps to develop the necessary discipline. Crucially, it also gives you time to recover from those inevitable early mistakes.
• The compound gains from a growing portfolio should, over the long haul, dwarf the interest payments on a static mortgage debt.

1. First things first 2. Should you invest before paying off your mortgage? 3. Do you want growth or income? 4. Diversification: summary 5. Diversification: Safe custody 6. Diversification: asset allocation 7. Diversification: shares 8. Diversification: sectors 9. Diversification: countries 10. Balancing your portfolio 11. What should you hold where? 12. Tips for married couples 13. Lump sum or drip feed? 14. The role of cash 15. Rebalancing your portfolio 16. What to do with dividends 17. All about bonds 18. What to do if you inherit a portfolio 19. Benchmarking performance 20. Setting up a portfolio spreadsheet 21. Conclusion

• One Up on Wall Street