Thursday 18 August 2011

Why young people should NEVER invest their CPF savings?

In the course of conducting investment reviews for my younger clients, I have observed that many of them have invested a large portion of their CPF monies and have suffered substantial losses due to the 2008 recession.  I will put forward several reasons why young people below the age of 30 should never invest their CPF monies. 

They are namely:
·         Large capital outlay ahead
·         Short time horizon for CPFIS – OA investments.
·         Risk free rate of 4% for CPF Special account is attractive
·         Risk adjusted returns for CPFIS investments is not a good deal

Large capital outlay ahead
    The majority of young couples, would be looking for a build to order (BTO) flat in Singapore if they intend to marry young. In order to apply for a HDB concessionary loan, one has to ensure that all monies under the CPF ordinary account is utilised before the loan can be approved.  CPFIS-OA investments made may need to be liquidated in order to make the down payment or service monthly instalments.

    Short time horizon for CPFIS-OA investments
      Under the CPF investment scheme, only monies in excess of $20,000 in one’s Ordinary Account and $40,000 in Special Account can be invested.  To accumulate $30,000 in one’s ordinary account, a young graduate earning $2,800 monthly will need about 4 years (Based on current CPF contribution rate as of 1 July 2011). For an average Singaporean male graduating at age 25, he only has sufficient CPF monies to invest at age 29. The mean marriage age for Singaporean males is about 30 – 31. In investment terms, it means one only has a time horizon of 1 to 2 years, which is too short. As economic cycles become more volatile and more frequent in recent decades, it is highly likely that losses will be incurred on the CPF investments as one do not have the ability to adopt a buy and hold approach.

      Risk free rate of 4% for CPF Special account is attractive

        When I was working in the retail banking channel, I often see large queues of Singaporeans whenever there are fixed deposit promotions above 1.5%. Many Singaporeans understand that due to the low interest rate environment, it is difficult to find low risk vehicles that pay high interest rates. However what is ironic is that these same Singaporeans often forego the guaranteed interest rate offered by the CPF board to invest their CPF monies.

        In many ways CPF Special Account savings are good investment bargains. Where else can one get a riskless return of 4%, the current rates for CPF Special Account (SA). Savings in the SMA currently earn either 4% or the 12-month average yield of 10-year Singapore Government Securities (10YSGS) plus 1%, whichever is the higher. As interest rates are at historical lows now, there’s only one direction it can move and that is upwards. My personal opinion is that the CPF Special Account is very likely the most secure, AAA rated, risk free asset in the world today. 

        Risk adjusted returns for CPF investments not a good deal.
          From 1900 to 2010, the historical nominal rate of return for equity is 8.6% per annum. Doesn’t investing monies into an equity fund earn higher than the interest rate of 2.5% earned on CPF ordinary account?  In investments, most fund managers consider an investment by looking at its excess return, which is the return above the risk free rate (We shall use 2.5% as risk free rate if investing ordinary account monies and 4% as risk free rate if investing special account monies).  So if one can earn 2.5 % for sure, an investment that gives 8.6% return IN THE LONG RUN is only delivering 6.1% of excess return. This is known as the equity risk premium. It is not a worthwhile investment if one takes a lot of risk to get the potentially higher returns. The CPF investment is just as likely to lose money if the market moves against us.



          Source: CPF Board,

          The long term objective of CPF is to provide financial security in old age. In my opinion, the CPF board is quietly against the idea of Singaporeans withdrawing monies for investments as investment losses on CPF losses may adversely affect retirement funds. The recent regulations of minimum sums before investment is allowed are meant to curb speculation among CPF members as well as preventing rogue advisers from targeting young, inexperienced investors.  It is recommended that one should go through a simple financial planning session before committing to any CPF investments. (See: Difference between financial sales & financial planning )

          Most young people below 30 will have a combined balance of less than $60,000 (Ordinary + Special + Medisave) should preserve monies in their CPF accounts to earn the additional risk free 1% interest (up to $20,000 on the ordinary account balance as of 1st July 2011). It is more prudent to let the compounding effect of interest work to our advantage rather than take unnecessary risks with a short time horizon.

          The ability to beat the risk free rate using CPF monies depends strictly on 2 factors, a long time horizon and a diversified portfolio, factors that young people do not have.  

          If you have invested your CPF monies, suffered a loss, and wish to seek independent opinion whether you should keep or terminate your existing CPF investment. Feel free to contact me at 8183 2979, I will be glad to assist you with a simple review.

          Do read my other articles:     CPF System and its application of behaviorial economics
                                                      Are young people investing or gambling?


          1. Gary, just a few points:

            1. CPF SA rates of 4% are valid till 31 Dec 2011 only.

            2. Even if existing rates remain, it would not be able to match up to inflation.

            3. By the time you reach the drawdown age, the Minimum Sum (MS) could well exceed whatever amount left in your CPF account.

            4. Contributions to CPF are irreversible. Even if your money grows well in CPF, other than paying the mortgage, you cannot utilise it.

            5. The opportunity cost is too high to leave monies in CPF.

          2. Ultimately I feel it depends on the shares that you buy and the approach of your investment strategy. I do agree that younger working adults below age of 30 should not invest for the sake of investing. However if we have sufficient in our CPF (more than 60k combined) we should explore other means of getting more than 2.5% fixed returns which CPF confirm is giving us. We can choose to buy shares like SPH, M1, Starhub etc which pays dividends which are more than the annual 2.5% we get when leaving in CPF and it will mean making our money work for us.

          3. Hi Samuel,

            Appreciate your comments, the scenarios you highlighted are relevant although it is based on certain assumptions. Thanks for bringing them up. Allow me to explain the 5 points you have brought up:

            1) CPF board revises their interest rates for OA, SA & MA every quarterly, so no one knows whether the floor rate of 4% for SA will be maintained come 1st Jan, 2012. The average yield of the 10YSGS plus 1%, from 1 June 2010 to 31 May 2011, still works out to be 3.35%, which is still decent in a RECORD LOW interest rate environment today.

            2) Yes, Government published inflation as of May 2011 is 5.2% however the historical inflation rate is about 2.73%. This is a grey area as inflation experienced by an average Singaporean may be higher than that of the CPI figures.

            3) The same question can be asked if investing CPF funds guarantee that one can can meet minimum sum at retirement? In fact, there is also a chance it will perform much worse compared to if one let their monies compound at a 2.5% interest.

            4)Contributions to CPF can be withdrawn as cash if one's balance exceed CPF minimum sum at age 55, it can also be left as an estate for loved ones when the CPF member pass on.

            5) The opportunity cost of leaving monies in CPF in economic terms is the POTENTIAL higher returns from investing, so whether it is high or not depends on the actual returns.

            Examples of CPF members who made substantial losses include pre-retirees who bought technology funds at the height of the dot com bubbble in 1999, most of them lost 70-80% and are unable to recover until today.

          4. Check out SM Goh's comments on CPF investments


          5. Used up CPF money to invest will affects your property ownership in the future.
            Using CPF money to invest in property is safer than stocks provided you have sufficient calculated risk.

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