I've come into a large amount of money. Should I invest it or pay off my mortgage?
There is no obvious answer. It all depends on your specific situation and your tolerance for investment risk.
From a pure economics standpoint, if you think that the after-tax return that you expect to earn from investing your new sum of money is higher than the after tax cost of the mortgage, then it makes sense to invest the funds rather than to pay off the mortgage. That's the theory.
In practice,you should consider where you stand on the financial life cycle. No matter what the economics, if you are close to retiring, getting rid of your debts should be a higher priority than if you are in your thirties for example. Additionally, managing funds requires investment skills and temperament that many people do not have. You also need a bit of luck. Going back in time a bit, if you were asking this question in November 2007 and had decided to invest, no matter what your level of investment skills, you would have quickly regretted not paying off the mortgage.
There is a risk with investing the funds that you do not incur by paying off the mortgage. Your level of risk tolerance matters. I hope this helps.
How about both? Invest in a portfolio of stocks that pay a dividend and have historically increased their dividend over time. Receive the dividends as cash and use the added income to pay extra on your mortgage, or reduce your out of pocket mortgage expenses. In the end, you will have a paid off home AND a nice portfolio.
When I get a large sum like that, I'm going to invest it. My number one financial priority is independent wealth. To achieve this, I need enough money to be under financial management so that, assuming a prudent interest rate, the annual yield will be enough to pay my expenses and support my lifestyle. This way, I can work because I want to, not because I have to.
Becoming debt-free is a secondary objective. I certainly don't want any debt, because that inhibits your freedom. But I’d be willing to carry a mortgage and consider the payments to be normal expenses if I could have a lump sum spinning off income to pay those bills.
Given the choice between being debt-free (no mortgage) and work-free (don’t have to work to pay my bills, even debt payments,), I would choose the latter easily.
I'm a fan of a paid-off mortgage. Many people will tell you not to give up the tax write off from mortgage interest. However, if you look at it as a whole part of your finances, that makes no sense. Say you are paying $10,000/year in mortgage interest and are in the 25% tax bracket. Your IRS write off will amount to about $2,500 back to you at tax time, but that's still $7,500 that just goes to interest to the bank. In other words, the write off still leaves you $7,500 in the hole for cash flow.
If you don't think you will be in the house for very long, don't pay off the mortgage and tie up the money in an illiquid asset (the house). If you do plan on staying in your house for 5 years or more, pay that debt off and enjoy mortgage-free living.
I hate to be vague, but it depends on other debt, your goals, other risks, etc. For some, they just like to have it off their plate and have nothing to worry about. If it is an expensive debt with a high interest rate and you still have some liquidity, like an emergency fund, then pay it off. If you need to maintain some liquidity, then payoff a large chunk and keep the rest for an emergency fund. You want to make sure you are in a position to ride out any storm, you don’t want to be forced to sell something or takeout bad debt.
If it is cheap debt, and you have a good history of staying within a budget and the numbers look good for meeting your goals and growing assets, then keeping some of the debt might be an option.
The answer is usually somewhere in between. Just make sure you take an honest look at what you will spend and what your risks are.
Mark Struthers CFA, CFP®