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Pay down the mortgage or invest?

In answering a question from a recent home buyer who seems to have a keen mind for personal finance, I say invest.

This person recently bought a house with a down payment of more than 20 per cent, which means the cost of mortgage default insurance was avoided. In addition, this individual has enough of an emergency fund to cover a year's expenses, plus future house and car maintenance. There's also a travel fund to cover future vacations, and a small amount of money invested.

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Score this person as an A+ in personal finance, up to now. To keep that grade, this individual will need to pick the investing option instead of the mortgage paydown. Ask a dozen personal finance experts about this kind of thing and you might easily end up with six picking the mortgage and six picking investing. My case for investing is that this person has a financial imbalance that would be fixed by directing new money into investments.

Paying the mortgage on the house means this person is building home equity. Having lots of cash on hand means an emergency fund is ticked off as well. What's missing is a long-term investing strategy targeted at things like retirement, taking a sabbatical year, upgrading credentials for work and more. Let's label these goals as plans for 10 years from now and longer.

Retirement would be the top goal here, unless this individual has a great pension plan at work and figures to remain at this employer for a good, long time. Many young people can't afford to save significantly for retirement because they're cash-poor home owners. And yet, you get a huge benefit from starting young through long-term compounding. A 30-year-old who invests $5,000 per year for 30 years at an average return of 5 per cent would end up with almost $349,000.

Come retirement, having this much in savings will be more of a comfort than a mortgage that was paid off a few years ahead of schedule. Those who are really bugged by having a big mortgage should remember this: If you make accelerated bi-weekly payments, you've reduced a 25-year amortization down to about 23 years. Add a few random prepayments over the years and you might get than down to 20 years. The mortgage takes care of itself, in other words. Retirement saving does not. You have to look after it yourself.

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