There’s a common question we come across again, and again, and again. You’ve probably seen it before, or at least a variation of it. It goes like this:
“I have extra money left at the end of the month, should I overpay my mortgage or…”
There are many options for the second part of the question, although “…invest the money” or “…contribute more to a pension” are the two most frequently occurring ones. The topic has been covered roundly, including articles by Monevator (not once, but twice), a more recent variation on the theme by Gentleman’s Family Finances and various other sites including Money Saving Expert. We found ourself lapsing into a state of relative apathy towards the question. Not that we find it in and of itself uninteresting, but reading the same old, carbon-copy responses became wearisome.
Part of the issue is that, although the cut and thrust of the underpinning economic argument remains fairly consistent, the different personal factors involved are too numerous to create a suitable one-size-fits-all answer. Undoubtedly being in such a situation is fantastic; you literally have so much money you’re unsure what to do with it! Whilst mulling it over, we decided to use a different framework to address the question. We thought we’d share it with you; perhaps it will help you in your search for a solution as well.
Johari and Rumsfeld
The Johari window is a tool originally designed for understanding oneself and your relationship with other people, using a 2×2 matrix of what is known and unknown to both you and to others. It’s primarily a learning exercise, as you seek to find that which fills your ‘blind spot’ or is ‘unknown’. As this information becomes known, i.e. migrates into the ‘arena’, your knowledge of yourself improves. Similarly, sharing items that populate your ‘façade’ box will improve inter-personal ties.
The window can be adapted in a system based on the famous words of former US Secretary of Defense Donald Rumsfeld. Both the Johari window and the so-called Rumsfeld box can be used in a broader fashion than just self-awareness, and using them as a framework is exactly how we chose to tackle the ‘overpay mortgage vs. other’ question. Populating the matrix with factors that influence an answer to the question creates, in our opinion, a clearer picture of the balance of risks/benefits. With this more robust understanding in place, answering the question becomes that bit easier.
The ‘Known Knowns’
These are factors that lie in an open forum, of which both you and everyone else is aware. Examples might include: current Bank of England base interest rate, current mortgage interest rates, inflation, interest from savings accounts, and historic stock market performance. Items in this box can help build the foundation of an answer. We know that if mortgage interest rates were lower than real investment returns, the maths alone would dictate that you’d have made more money by investing than overpaying the mortgage.
Factors in this box are relatively ‘low risk’. That isn’t to say the risk of losing money is less, but that these items are more certain in their nature. As such the impacts they’ll have are more predictable and consequently they’re less risky.
The ‘Unknown Knowns’
The ‘unknown knowns’ are perhaps the most difficult to define. These are components that are known by others but unknown to you. One example might be a deeper insight into some of the economic phenomena that will affect the answer to the question. A good proportion of the FI community won’t have a significant grasp of economics beyond the extent of their own research, which may have ignored, misunderstood or otherwise left out pertinent information.
The other collection of factors in this box are things that we do not care to know; facts we wilfully ignore as they do not fit our existing schema of understanding, facts we dismiss out of confirmation bias. There’s a wide spectrum of elements this could cover; personal, professional or purely financial. An example could be that, despite having never experienced a market crash before, you’re certain you’ll be immune to the urge to (panic) sell as the market crumbles – yet what we know about human and investor psychology says most people won’t be. Another might be that, instead of over-paying the mortgage, you’re dead-set on investing in Cryptocurrency because you feel it’s a guaranteed path to El Dorado – yet the data shows Cryptocurrency has proven to be a highly volatile (and therefore unreliable) investment.
These elements carry higher risk; they are unknown to you and the impact they may have is less predictable. As such the goal is to move them into the ‘known knowns’ box. That might be through broader or deeper learning, or acknowledgement of when you’re succumbing to your own biases. Being mindful of the presence of these factors is possibly enough, even if you’re unable to shift them all into the ‘known knowns’ box.
The ‘Known Unknown’s‘
Constituents of this quadrant of the matrix tend to be of a more intrinsically personal nature. Within this domain lie several considerations, such as:
• your relationship with money, savings and salary
• your psychological approach to debt; does the mental weight of owing money override other factors?
• personal facets including your age, family situation, expected longevity
• more detailed financial factors e.g. your exact mortgage details (term, rate, overpayment facilities, proximity to LTV brackets etc.)
It is sometimes difficult to decipher your own feelings on these matters and a healthy dose of introspection is sometimes required to get a grip on them. One way of better understanding these personal factors is to plan scenarios and try to anticipate your response. That might be any combination of: outrageously good/bad investment returns, significant rise or fall in mortgage interest rates, loss of or bountiful increase in income, or changes in other personal circumstances.
The ‘known unknowns’ are likely to impact on various other facets of your financial and personal success, so understanding them is important beyond the scope of the ‘overpay mortgage vs. other’ question. Fortunately, the elements in this box will tend to be of lower risk as you can, with enough aforethought, somewhat predict the impacts they’ll have.
The ‘Unknown Unknowns’
The unknown unknowns are items and events masked by the haze of the future, clouded in the fog of war, refracted by the crystal ball. Tucked in just below the dividing line of the two right-hand boxes is the actual, future return for any given investment. Nobody can know for sure how it will perform. Some may have the resources to try and predict returns, which translates into the cost of investing in an actively managed fund. The reality is that, certainly for the vast majority of us, future investment performance is a relative unknown unknown.
We’re in the midst of an unknown unknown now – who could have accurately predicted the advent of the Covid-19 pandemic, or known the timing of its subsequent socio-economic impacts? The 2008 global financial crisis was similarly sprung upon the vast majority of people who were none the wiser. Sudden, life-changing events also fall into this category, e.g. changes in the health of you or your family, changes in employment or relationship status.
As a result of being largely unforeseeable, these elements carry a relatively higher risk. Agreeably the unpredictable nature of factors in this box make them difficult to plan for – is there any value in considering them? Disregarding factors in this box might compound the effects they have. As they’re the type of events that might necessitate a reasonable amount of financial liquidity, tying up all your money in relatively illiquid vehicles (e.g. mortgages, pensions, investments) leaves you at their mercy. Conversely, the problem with overweighting importance to this domain is the trend to nihilistic thinking. “If nuclear armageddon might strike tomorrow then I might as well spend the money rather than invest or pay off the mortgage”. If unpredictable, calamitous events are the only rationale behind spending your money then you might never save! That’s not to say, however, that spending money instead of investing or paying off your mortgage is a bad option.
Example – the outcome of the thought process:
“I know that if future investment returns mirror historic returns I would make more money investing instead of paying off my mortgage. However I prefer to have no debt at all and even having a mortgage grates on me. I’m also near an LTV bracket so could remortgage for a better rate if I reached it. My job security is low and I may end up changing careers, so I don’t want all my money tied up in an inaccessible way. I think that the chance of future economic downturn is guaranteed, although I don’t know when, but want to keep some money liquid. As such I’ll split my spare money into 50% mortgage overpayment, 30% investments and the rest as cash.”
Strike the Balance
Ultimately, the answer to your own personal ‘mortgage vs other’ question needn’t be binary, nor absolute. You might decide that the net outcome of the ‘mortgage matrix’ is a split of your spare money between your mortgage and other vehicles. Similarly, you could rehash the problem on a recurring basis to check the balance of factors, assess how they’ve changed and modify your approach as needed. In any case, we hope you find the matrix useful – let us know how you get on with it.