INSIDE INVESTOR: What to do with your spare cash - pay off the mortgage or invest?

What do you do with all that spare cash?

In case you haven’t noticed we’ve had a series of interest rate cuts in the past 12 months that have lopped 1.5 percentage points from the interest bill on your mortgage. While not all of it has been passed on, the bulk of it certainly has.

Like almost everyone in the developed world during the past four years, our attitude to debt has changed. We now look at debt like it is some kind of disease. Getting your debt levels under control and even becoming debt free isn’t a silly thing to do. It can be a liberating experience. But sometimes it makes more sense to put at least some of your money to work.

As a simple rule of thumb, it is best to repay debt when interest rates are high. At the very least, if you are thinking of paying off your debt, look to pay your most expensive debt first. That would be your credit card. It is silly to pour all your spare cash into your mortgage and leave debt standing on your credit card at a much higher rate.

As interest rates move lower, however, you can get more bang for your buck if you think of investing. If you are making extra payments on a mortgage that is charging you say six per cent, effectively you are getting a six per cent return. As rates come down, you are effectively getting a smaller return.

But putting extra cash into your superannuation fund or even investing directly can deliver better returns as rates come down. Lower interest rates tend to fire up the stock market because companies reduce their costs, delivering bigger profits, while consumers tend to spend more.

Governments and most big companies borrow money to invest in projects or equipment. They borrow at, say five per cent, in the hope of getting a 10 per cent return. During 2012, the stock market delivered gains of around 13 per cent. So if you had applied some of that cash you’d saved on mortgage repayments to an index fund, you’d be well in front.

Superannuation has done well in 2012 too, primarily because the stock market is up. And remember, you get a tax concession on contributions up to $25,000 on your super.