Before you spend your bonus money on consumptive activities, you should look at your own financial conditions first. Do you have any debts you need to pay? Using your bonus money to pay debts may not sound appetizing, but it sure is important. Next, do you think you have sufficient investment for your age? If you believe you should add more to your investment portfolio, then bonus money can be an excellent starting point. Do you have enough money in your savings account to hedge against unforeseen difficulties in the future? Do you already have a health insurance policy? If your answer is no to the latest two questions, then perhaps the most prudent option is to save your bonus money or to purchase an insurance policy.
Recently some experts have been arguing that people should use their annual bonus money to pay off property mortgage or house installments. This suggestion appears to be very sensible at first, especially in a society like Singapore where home ownership is both a life milestone and a culturally sensitive matter. Furthermore, it is also true that using your bonus money to pay a mortgage will make a pretty big dent in your loan, much larger than your usual monthly installments. However, this suggestion deserves a closer look. Is it really such a good idea after all?
If you don’t have any debts of the kind mentioned above, then we can move on to the main question: should you pay off your mortgage with bonus money? To answer this question, the first variable you need is your mortgage interest rate. Then, you should spend a few hours to examine any investment options you may take with your bonus money. For example, you may invest in stocks, bonds, mutual funds, foreign currencies, derivatives, and so on. Each of this investment types have their own expected interest rate / profit and maturity period, or the duration of your investment. Naturally, each also have their own degree of risk.
What you can do at this stage is to utilize a statistics concept called expectation. To get the expectation from each investment option, you multiply each probable return with the probability of getting that return, then sum the products. Then, rank all the investment options and pick the one with highest expectation, putting risk and maturity period into account. Finally, compare this expected return with the amount of money you’d save by paying off your mortgage a bit faster. Choose whichever option provides more return to you.
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