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How best to invest $10,000 over 10 years.
Strategy 1 – Paying off high-interest debt
Strategy 2 – Paying extra to the mortgage
Strategy 3 – contribute more to Super
Strategy 4 – Invest outside of Super
Let’s take the example of someone on the average tax rate (32.5 % excluding Medicare) who has $10,000 of savings to invest over 10 years.
High Interest Debt
For those with high-interest debt (credit cards or personal loans), the argument to pay down the debt with the $10,000 is almost impossible to deny. Assuming an interest rate of 17.5 per cent, $10,000 would incur interest costs each year of $1,750. The total interest saved over 10 years would amount to $17,500 – an impressive effective return.
Paying down the home loan on the other hand is not as clear cut.
Making Extra Home Loan Repayments
Paying off the family home has long been argued to be the best course of action for most people. However current low interest rates muddies the water somewhat. An extra $10,000 paid to a mortgage with an interest rate of 4 per cent per annum leads to a saving of interest over 10 years of $4,802. It is a conservative and risk free approach and certainly superior to a savings a/c or term deposit.
It protects somewhat against the risk of rising interest rates. But it isn’t necessarily a no-brainer, depending on your situation.
An Investment Outside of Superannuation
There are of course many means in which you can invest, so we need some form of benchmark for this one. Taking a 20 year return of the domestic sharemarket, encompassing the GFC, means an average annual return of 7.7% p/a. If a $10,000 investment were to receive an after-tax return of 7.7 per cent per year for the next 10 years it would compound to $20,997, an investment return of $10,997 when you take out the original $10,000.
Obviously this is far in excess of the return on the homeloan, but it encompasses risk that the homeloan does not.
Adding to Super
The change to superannuation rules now allow most people to claim a tax deduction from making a personal contribution of $10,000 to superannuation. For a person on the average tax rate (32.5 per cent), a $10,000 tax deduction leads to a reduction in income tax of $3250. We will assume that the person chooses to make a superannuation contribution of $13,250 (being the $10,000 and the $3250 income tax saved), which becomes $11,262 after the 15 per cent superannuation contributions tax. Assuming a similar return as per the last strategy, over 10 years this would have resulted in the original $10,000 saved turning into $23,735, or an investment (and tax) return of $13,735.
This would appear to be significantly more attractive than making additional mortgage repayments or investing in shares outside of superannuation – however it is worth remembering that superannuation has restrictions around access, and these investment returns are also ‘risky’.
The obvious strategy is to focus on high interest rate debt if you have it. After this, your age becomes a key factor. If you have a short to medium term timeframe before potentially retiring or being able to access Super, the benefits of an instant return on your money in the form of a tax concession is very attractive. If you have many years until retirement, then additional homeloan repayments can save you tens of thousands of dollars in avoided interest. For those that lie between these two extremes, a combination of these two strategies may be a suitable option.