Earlier this year, it was reported that 85% of Singaporeans who invested their CPF money would have been better off simply leaving it untouched in their CPF accounts.
This begs the question of why average Singaporeans would be enticed to invest their CPF monies?
CPF Already Pays A Good Interest Rate
Haters will be haters, but let’s face the fact; CPF pays a really decent interest rate on the amount you are holding in your account.
CPF members earn a risk-free rate of 2.5% and 4% for money in their CPF Ordinary Account (CPFOA) and CPF Special Account (CPFSA) respectively. There is also an additional 1% given for the first $20,000 and $40,000 in your CPFOA and CPFSA respectively. This is automatically compounded and members do not have to worry about any downside risks.
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CPF Investment Scheme (CPFIS)
CPF members have the option to create a CPFIS that would allow them to use money in their CPF to invest in a variety of financial instruments. Some of these products include Fixed Deposits, Singapore Government Bonds, Unit Trusts (UTs) and Investment-Linked Insurance Products (ILPs).
Up to 35% of your investible savings can be invested into stocks, property funds and corporate bonds. Investible savings refer to amount above $20,000 for CPFOA and $40,000 for CPFSA.
The Opportunity Cost Of Investing Your CPF Money
Here’s the thing. Unlike money sitting in that lousy savings account which gives you an annual interest of 0.05%, money in your CPF account actually works harder for you by generating a return of 2.5% to 4% per annum (depending on whether it is your OA or SA).
We don’t know about you, but if we were intending to invest some money to grow our wealth (e.g. buy some stocks), then we would prefer to be using money that is not generating good returns for us. That would include any savings that beyond an emergency fund consisting 6 to 9 months of living expenses.
Understanding Risk Premiums
Only 15% of Singaporeans who invested their CPF money last year made more than what they would have received if they had just left it in their CPF accounts. Should these people be happy with their returns? Not necessarily so.
One thing that retail investors sometimes forget is the definition of “risk premium”. “Risk premium” refers to the additional return an investor should expect to obtain because of the additional risk that the person is taking.
For example, a person who is investing in the stock market should expect to get a much higher return from their investments compared to a person who keeps it in his or her CPFOA.
Of these 15%, we don’t know how many managed to beat it by a good margin. Simply beating the risk-free rate by a couple of percentage points for those who have invested their CPF money elsewhere is no cause for celebration, not when they are taking more risks in their investment. And this is not even considering the extra time and effort devoted to understand the investments they were taking.
Additional Transaction Cost, Expense Ratio, Distribution Cost
Another factor that most people don’t recognise is the additional cost they incur when investing their CPF money.
Most investments incur some form of transaction cost. Even when you buy the Singapore Savings Bond, you still have to incur a $2 bank charge.
One rule of thumb for long-term investing is to always try keeping your cost low so that you can maximise your returns.
CPF members do not incur any cost when they keep their money in the CPF account to earn the risk-free returns. In fact, they can even get a tax reduction when they top-up their CPF account.
Contrast that to investments made via CPFIS. When you buy or sell stocks, you incur brokerage charges, in addition to any profits or losses you may have made. If you buy an ILP or an endowment plan, you not only incur high distribution costs (which can easily amount to about 2 years of your premium), but also incur annual expenses, which could be about 1.5% per year.
[BEWARE]: The Financial Industry Has Incentives To Encourage You To Invest Your CPF Money
When you keep your CPF money safely in your own account, you generate a stable return given to you by the Singapore Government. No other financial entity or individual makes money from your decision.
The industry makes money when you decide to invest your CPF money. Brokerage firms will generate revenue from the buying and selling of stocks that you made. Insurance companies will earn profits from the investment-linked insurance products (ILPs) or endowment plans that you buy. Insurance agents will get their commission from selling you these plans. Fund managers will earn management fees when you buy into the unit trust that they are managing.
Because of these reasons, it is not difficult to understand why the stakeholders in the financial industry will find all means, including giving free pots and pans and maybe even a kitchen sink, to entice people to invest their CPF money with them.
And unlike cold hard cash in their bank accounts, some Singaporeans may find it more acceptable to part with their CPF money because they think they can’t use it, even though it is earning a higher return than the money they have in their bank accounts.
Ultimately, it is your CPF and hence, your choice. You should make sure you make a smart, logical decision with regards to these funds that are meant for your retirement.
Bonds and Fixed Income