CPF Investment Scheme – When should you seriously consider using it?
“Many CPF Investors get their fingers burnt” reads a news headline that was reporting on figures published by the Central Provident Fund (“CPF”) board on the realised profits and losses for CPF members from 1st Oct 2013 to 30 Sept 2014. In total, about 40% of investors realised a loss when they sold their investments and 45% did not outperform the 2.5% interest returns that they would have earned if they did not invest.
Yet in the same report, it stated that the CPF investment scheme funds have performed well and have “grown by 29% over the past three years”. In fact, 15% of investors or approximately 140,000 investors realised gains of more than 2.5% over the same period.
While there are good investment choices available that meet the stringent guidelines set by CPF such as good performance track records and capping of expense ratio, many investors may not be approaching the topic of investing their CPF correctly.
To better understand if you can benefit from investing your CPF, you should start by learning more about the CPF-Investment Scheme.
What is CPF Investment Scheme (“CPFIS”)
The CPFIS is the scheme that give CPF members more options in investing their CPF savings. There are many types of investment choices available to suit different investment objectives and the main goal of the scheme is to help enhance retirement savings.
Some of the investment options available under the scheme includes Unit Trusts, Investment-linked Insurance Products (“ILPs”) and other professionally managed investment products. The details of the CPFIS including investment limits are available on the CPF website and from there, you can get a good understanding of the scheme.
While there are benefits to using CPFIS to invest, especially when you have both the risk appetite and the long time horizon to invest, you should be mindful not to be attracted purely by the promise of returns.
Exercise Prudence – When should you not invest?
In my opinion as a financial planner, here are 3 situations where you should avoid investing your CPF funds:
a. You are not ‘Build-To-Risk”
When it comes to investments, there are no guarantees so if you are someone who is unable to accept the possibility of losing some or part of your capital, you should avoid investing. To begin, you can use this Risk Tolerance Questionnaire provided by CPF to assess your tolerance or attitude towards risk taking.
In addition, you may also consider getting the help of a financial planner to conduct a risk profiling exercise. Risk profiling questionnaires are useful in general profiling but speaking to a professional will help you uncover deeper factors that can result in a more accurate profile. I have personally seen clients who has on paper one type of risk profile and upon investing, changes to a different (usually much lower and safer) risk profile.
Such investors are likely to deviate from their investment plans and sell too early (i.e. before their planned investment time period), especially during market downturns and this can result in a loss.
b. You have short-term goals that require the use of the CPF funds
Besides the primary purpose of providing for retirement income, CPF funds can also be used for other needs. The most common example is the use of CPF ordinary account savings for financing the purchase of a property. Another possible use is for paying for yours, your spouse or your child’s education through the CPF Education Scheme.
If there are already concrete plans to use the CPF funds in the near future (e.g. 3 years’ time), it will be prudent not to invest your CPF. You will not want to force-sell your funds at an inopportune time because you need the funds urgently in the middle of a market downturn.
c. You are close to age 55 (or your planned retirement age)
In my opinion, the 5 years before and the 5 years after retirement are probably the worst possible time to lose money in investing. Besides the obvious reason that there is not enough time to recover from the loss, there is also the additional loss incurred due to “sequence risk”.
By having to retire and begin drawing down on your investments during a market downturn, the funds will diminish at a faster rate than planned leaving you with a greater risk of running out of money earlier.
Before You Start – Know Your Goal
If you are not affected by the “prudence factors” mentioned, you can consider investing your CPF funds and generally speaking, having a process and a plan will improve your odds of being successful. Financial planning is about creating a process and plan with the first step being to identify how much you need or the “financial goal”.
Having a goal is not just about having a number but more importantly, using the number to help you choose the right investment. For example, if I were to ask you to travel from Bedok to Clementi, what type of transport will you chose? With so many choices available such as taking a bus, using the MRT, calling Uber, taking a cab, self-drive or even a “no cost” option such as cycling, how do you determine which is the most suitable?
However, if I were to ask you to choose again but this time with the condition that you have to reach Clementi from Bedok in 30 minutes or less, what transport will you then choose? Suddenly, the options are clearer and despite cycling being the “lowest cost” option, you will unlikely choose this as the preferred sensible option.
Similarly, by doing your financial planning first and knowing how much you will need, you will then be able to understand the rate of return required and that can serve as a guide to select the right investment option.
As a rule of thumb, if you need more than the 2.5% or 4% return guaranteed by CPF in the Ordinary and Special Accounts respectively to be able to achieve your retirement goal, you should consider the option of investing your CPF assuming you don’t have the “prudence reasons” alluded to earlier in the article.
How do you invest – Here are 3 Strategies to Consider
1. Transfer from OA to SA
Earn the guaranteed interest rates by transferring your CPF-OA funds to CPF-SA. There are limits to what is allowed but this will enhance your returns by 1.5% with very little risk. However, do note that the transfer is irrevocable so this option should only be taken after careful consideration. Moreover, you must be sure that the additional return of 1.5% will be able help you to achieve your financial goal.
2. Manage it yourself
The benefits of managing your own investments is that you will enjoy better control over the investments and lower costs. However, in return, you must be able to set aside time consistently to manage the investments. It’s not about beating the CPF benchmark interest rates over a year or two, ultimately what will matter is being able to outperform the CPF benchmark interest rates over a 20 to 30 year period and be able to meet your investment goals at the same time. Be truthful with yourself about the ability to make the time commitment if you chose this option.
3. Have it professionally managed
This is suitable for people who are busy and will need to leverage on the time of professionals. Another group of people who are suitable are those who have no knowledge in investing. There are additional costs involved so you need to consider the trade-off between the additional fees against the cost of your time. An additional benefit of engaging professional help is that a financial planner will also be able to calculate and advise on your risk profiling, ascertaining your financial goals and help you to build a portfolio instead of investing through a “products” strategy.
Preserve Your Purchasing Power
Considering that the annual inflation rate in Singapore for the period from 1962 to 2017 is 2.65% a year, not investing will almost certainly guarantee that for many of us, we will not have enough for a normal retirement. Yet, for those who invested, many have lost money despite the availability of good quality investment options. Perhaps, because of this fear of loss, some people have decided to be passive and accept the “cost” of inflation.
Consider a Mixed Asset Fund
During financial review meetings with new clients who are introduced to me, I often enquire about their plans for CPF investing. Often, they will share that as their finances stabilise, they are open minded towards the idea of investing a portion of their CPF but because of the negative news that they’ve came across, they wanted to learn more about investing before they start. The problem is that they are so time-challenged that they could never go around learning all that they need to learn. Yet, the need to invest and the effects of inflation will continue to affect them.
For people in such situations, I will suggest to them that they can consider starting with a “mixed asset investment fund” that fits their risk profile. A mixed asset fund is an investment fund where the fund manager is able to invest across different asset classes such as equities and bonds.
In this case, the client do not have to worry about the market directions and leave the managing of the investment allocations to the fund manager. It’s a good way to get started in investing without having to set aside your personal time to manage.
To help you get started, you can use this “Guide to Mixed Assets Funds” which contains 2 examples of CPF-Approved investments funds to help better understand if this is the appropriate strategy to adopt.
To end, remember that a good investment plan is like your air conditioner – If it stops working, you start sweating. Good luck and have fun!
Article by Wilson Phang