Personal Finance

Should You Take 5% or Hold Out for More?

It's hard to find surefire ways to earn a significant return on your money these days. Many bank accounts are paying less than 1% interest, for example, and one-year CDs aren't offering much more than 1%. Still, if you have a mortgage, you can earn a lot more on your money with no risk whatsoever. But is even that return enough -- or should you try to do even better than that by taking on more risk?

Hiding in plain sight

Paying down your mortgage gives you a guaranteed return. If you're paying off a home loan with an interest rate of 5%, and your terms permit you to make extra payments, you're all set. Send in an extra $1,000 with your next mortgage payment and you'll forgo paying the 5% interest on that $1,000. That money will stay with you, effectively giving you a 5% return. If your interest rate is 6% or more, you'll be enjoying a heftier return.

Another benefit of this strategy is that you'll pay off your loan sooner. A 30-year mortgage can end up with a life of just 20 years this way, without your ever having to refinance. (If your current loan doesn't permit prepayments, consider refinancing into a loan that does -- perhaps a shorter-term one.)

Consider the alternatives

The surefire return isn't a complete no-brainer, though. There's a downside in the form of your opportunity cost. When you prepay your mortgage with $1,000, you're passing up other ways to invest that money.

One kind of stock you might consider is the solid dividend payer . Some companies currently yield more than 5%. Mortgage REIT Chimera Investment ( CIM ) , for instance, has a yield topping 14%, while Southern Copper 's(Nasdaq: SCCO) forward yield tops 6%. That beats the 5% mortgage approach handily, though it's not guaranteed. You'll want to study each candidate enough to be confident in it. Chimera might suffer when interest rates start rising again, but even if its yield is halved, it will still be compelling. Southern Copper's fortunes are tied to the price of copper, but demand for the metal is likely to grow as the world economy picks up.

Other companies may offer lower yields, but many are boosting those payouts significantly each year. Here are a few well-regarded examples to look into:

Company Recent Yield 5-Year Avg. Dividend Growth Rate
Sysco (NYSE: SYY) 3.6% 9.3%
Altria (NYSE: MO) 5.6% 9.4%*
New York Community Bancorp ( NYB ) 6.2% 10.4%
Nucor 3.3% 11.2%

Data: Motley Fool CAPS.

*Growth rate since spinoff of international division in 2008.

Altria's dividend growth rate has been steady since spinning off its food and international tobacco divisions. Sysco and Nucor, supplying restaurants and other businesses and cranking out steel, both stand to benefit from our global economic recovery. New York Community Bancorp, with low debt, has been acquiring other banks. It didn't need or accept any TARP money.

These kinds of promising dividend payers can give the mortgage-prepayment strategy a run for its money -- especially if you diversify your money between them, reducing your risk.

Fast growers

Finally, while dividend payers ideally offer steady dividend payouts as well as stock-price appreciation, other terrific stocks offer just stock-price appreciation , and, potentially, lots of it. Below, for example, are some companies with strong expected growth rates over the coming five years:

Company 5-Year Est. Avg. Growth Rate
iRobot 24%
Intuitive Surgical 22%
Visa (NYSE: V) 19%
JA Solar Holdings (Nasdaq: JASO) 16%
UnitedHealth 12%

Data: Yahoo! Finance.

These kinds of companies can perform well for you, with earnings growth easily topping 5%. You just have to accept some risk along with the potential reward. Some may flame out, which is why you'd never want to put too many of your eggs in any of these baskets. Solar energy seems here to stay, for example, but it's not yet clear which companies will be the biggest long-term winners. Note, though, that these companies are not all highfliers involved in brand-new technologies. Visa is a credit card giant, while UnitedHealth is a major health insurer. Both are businesses likely to last a long time.

It's all up to you, your risk tolerance, and your needs. Instead of just letting your long-term money languish in a bank account or CD, you can earn some solid returns, whether you prepay your mortgage, invest in dividend payers, seek out fast growers, or opt for a combination of these strategies.

One guy who's been earning way more than 5% for a long time is Warren Buffett. Read the Fool's new special free report, and you'll find three stocks that would make his mouth water.Click hereand see them for yourself today.

Longtime Fool contributorSelena Maranjianowns shares of Intuitive Surgical and iRobot. Sysco, UnitedHealth Group, and Visa are Motley Fool Inside Value recommendations. iRobot and Intuitive Surgical are Motley Fool Rule Breakers selections. Nucor and UnitedHealth Group are Motley Fool Stock Advisor picks. Sysco is a Motley Fool Income Investor choice. Motley Fool Options has recommended a diagonal call position on UnitedHealth Group. The Fool owns shares of Altria Group, Nucor, and UnitedHealth Group. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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