I’m sure you should have seen this announcement on the news by now – Government to review CPF Investment Scheme: Tharman. This couldn’t have come at a better time for me personally after having just discussed with my family last weekend about why I don’t think the CPF Investment Scheme (CPFIS) is a good idea.

What is the CPFIS?

Firstly, CPF employee and employer contributions are only applicable for Singapore Citizens (SCs) and Singapore Permanent Residents (SPRs). If you have more than S$20,000 in your CPF – OA, you can choose to invest the excess under the CPFIS – OA.

Likewise, if you have more than S$40,000 in your CPF – RA, you can choose to invest the excess under the CPFIS – RA. There are restrictions on the amount of CPF savings you can invest and the investment products you can invest in.

Can you beat the benchmark rates of return?

Since you can only invest the excess CPF savings, these are the benchmark rates of return that you are trying to beat.

If you refer to the list of investment products on the CPFIS webpage and consider the long investment horizon (can only access CPFIS after reaching 55 years old), it becomes obvious that only a few of the investment products can achieve that.

Since your CPF savings are inaccessible for a long time, you have to remember that it’s not good enough to beat the benchmark rates of return by a bit. It has to be sufficient to justify the risk you are taking by investing your CPF savings on your own and having it locked up for so many years.

Essentially, this leaves you with shares and property funds as the only viable investment products that can achieve such a superior rate of return. Let’s forget about fixed income investment products and other investment products that will hit you with high fees.

CPFIS – RA

You are not allowed to invest your money from CPF – SA in shares and property funds under the CPFIS – RA. If you are thinking of achieving it using ETFs, I reckon that’s going to be tough. You can only invest in these two equity ETFs listed on the Singapore Exchange (SGX):

These two equity ETFs only offer exposure to the Singapore economy and the next few decades are going to be difficult for us. It’s not easy for Singapore to find new drivers of economic growth and there will be an increasing need to balance that with social growth.

Which is why you are better off sticking to the 4% pa on your money in your CPF – SA. Especially when there are no equity ETFs listed on the SGX that offer you exposure to the global economy.

CPFIS – OA

Realistically, this means that your only option is to invest in shares and property funds using your savings from CPF – OA under the CPFIS – OA. Herein lies the biggest problem. It’s difficult enough to work out the above by yourself. Just speaking to my family over the weekend showed me how CPF might not be a major financial planning consideration for most people.

The older group in their 50s and 60s can’t do much anymore with growing their CPF savings. They just have to make sure they don’t lose their CPF savings on bad investments and  spend their CPF Life payouts wisely.

The younger group in their 20s and 30s are focused on getting better jobs or achieving higher income. Not so much on whether their CPF savings are sufficient for retirement. Although this is starting to change as more young people become focused on early retirement and financial independence.

This means it’s more likely for the middle-aged group in their 40s that start focusing on the adequacy of their CPF savings. That’s actually the worst time to start investing in shares and property funds using their savings from CPF – OA under the CPFIS – OA.

This group has the highest financial obligations (mortgage, children’s’ education, car etc). They lack the time to learn about investments in detail and suitable strategies or approaches. Since they haven’t practised and gained experience from investing smaller amounts of money in their 20s and 30s, doing so in their 40s with larger amounts of money and a lot more to lose can have disastrous consequences.

Now you can see how easily it is to make losses from underperformance due to behavioural biases in investments. Because the majority of people investing under the CPFIS are going to do so for the right reasons and motivations but with so little of the required skills.

Who should participate in the CPFIS?

Even with the statistics provided by the Singapore Government that 80% of those who invested through the CPFIS – OA would have been better off leaving their money in the CPF – OA, most people believe they can be the other 20%. Or worst, they reckon the Singapore Government is lying to them about the statistics to keep their money in the CPF – OA.

You want to know who should participate in the CPFIS? It’s people who have already built their own investment portfolio of such a size that it generates significant passive income such that they don’t actually depend on the CPF for retirement. That’s how you remove the possibility of underperformance from behavioural biases – by not needing the money at all so the long-term superior rate of return scenario can actually play out.

It’s about time the CPFIS is reviewed. We now have sufficient data as evidence that the current form does not benefit the majority of people. We need to take actions to simplify and improve the CPFIS to increase the proportion of people who can beat the benchmark rates of return.

The suggested CPF Lifetime Retirement Investment Scheme (CPFLRIS) is a good start. The recommendation is to offer a few well-diversified products with a single administrator and be passively managed. Investors will also be discouraged from churning or frequently switching their investments.

If the CPFLRIS comes into effect, CPFIS can be gradually wound down as it is no longer relevant since both schemes have the same aims. Even for the CPFLRIS, there is no need to have a few well-diversified products.

Just one investment product with an expected return of 5.5% pa as an alternative to the CPF – OA and another investment product with an expected return of 7% pa as an alternative to the CPF – RA will do. The more options CPF offer, the more it’s going to confuse people.

Which means the main thing CPF has to focus on is explaining to people the most important part of taking on more risk to achieve a higher return.

There are also benefits to risk pooling since everyone will have the same two alternative investment products. If CPF is worried about concentration risk, then it should not have been set up as the only retirement fund scheme for SCs and SPRs in the first place.

With the recent release of the Central Provident Fund (CPF) Advisory Committee proposals on the CPF Life Escalating Plan and CPF Lifetime Retirement Investment Scheme, CPF has now become the trending topic in Singapore.

There are a number of good news articles and analysis by personal finance bloggers and you should read them for a better understanding on these proposals. I was already planning to have a post about our views on CPF before their release and this seems like a good time to do so.

One interesting point I have noted the more I write on my blog is how my style of writing has developed over such a short period of time. I like writing about how we manage our personal finances and analyse issues from our perspective based on personal experiences. I don’t like writing about generic actions that you can take as a reader to improve your personal finances.

This does mean that my blog is likely to reach a smaller audience especially if you can’t identify with our circumstances. Maybe my writing style might evolve over a longer period of time but I would like to think this is a more useful approach to personal finance.

After all, managing personal finances is a very unique problem to each individual, couple or family. If I don’t write about how we approach it and our various issues, actions taken and results, how are you going to see the effects of what we write about?

What is the purpose of CPF?

Anyway, back on the topic of CPF. I like how actions are being taken to improve its adequacy for our retirement needs. I’m just not sure whether adding to CPF’s complexity by introducing another CPF Life Plan and CPF Investment Scheme is the way to go.

As we only have one national retirement fund scheme in Singapore, the probability of net outflows draining the CPF fully is low provided we can keep it well-funded by keeping the unemployment low.

CPF works well when you have full-time average paying jobs and can hold them from graduation to the age of 55 – 65 with minimal disruptions from retrenchments and medical emergencies. CPF works even better when you have full-time high paying jobs. Anything else, it will be a challenge to sufficiently fund your CPF.

Reason is simple – mandatory contributions of 17% by employer and 20% by employee up to a CPF salary ceiling of S$6,000. Even at an average monthly salary of S$4,000, that’s about S$1,500 of compulsory contributions every month. I doubt there is another retirement fund scheme out there in the world that forces you to contribute this much to it.

You can see the various issues straight away. Shorter job life cycles mean that it will get more difficult to hold such jobs consistently for 30 – 40 years. Noticed how unemployment is affecting the middle-aged workers much more lately? That’s us in 10 years time. Staying at home to take care of kids, part-time work and self-employment also means none to much lower contributions from both the employer and/or you over time.

Herein lies the problem. The message we are getting is that CPF is for retirement needs and people keep focusing on it as a retirement tool. It’s not. Our view is that CPF is a financial planning tool and it can address more financial concerns than just retirement.

With any changes to CPF, it’s important to understand which part of our financial plan is being impacted based on how we have designated the purpose of each account of the CPF. Of course, it’s essential you are aware that we are looking at our CPF in the broader context of asset portfolio management. You still need to focus on building your cash savings, investment portfolio, real property and other holdings.

CPF – OA: Housing

Our CPF – OA is only to be used for making our housing loan payments. Since we have only been working in Singapore for the past few  years, we try to use a greater proportion of cash for these payments. This allows for the CPF – OA to build up as a future payment source for our mortgage.

Even though more than 50% of our monthly CPF contributions is allocated to the CPF – OA, we don’t view it as retirement funds. Why would we use the CPF – OA for retirement in the future if we have the option to use it now for housing? Plus we earn interest of 2.5% p.a. on the CPF – OA balances and it’s hard to even get such interest rates on bank account balances.

This is why we don’t see any impact from the changes in the CPF Investment Schemes. There is little incentive for us to take on additional risk and participate in such CPF Investment Schemes even if they can achieve higher returns over time. We are happy to leave any excess balances in the CPF – OA knowing that our current and future housing needs will be taken care of.

CPF – SA: Retirement

Our CPF – SA is where we have designated the balances for retirement purposes. This is the true retirement account in our opinion since it can only be accessed from age 55 – 65. However, the CPF – SA has the smallest allocation of our monthly CPF contributions.

This should already be a red flag to anyone that the CPF – SA will be insufficient for retirement. Hence, we try to contribute cash to the CPF – SA for tax relief and transfer some of our excess CPF – OA to it where possible.

As our goal is to achieve financial independence before age 55 – 65, we have to put our cash to better uses for more returns. Besides, we earn interest of 4% p.a. on the CPF – SA balances not forgetting the additional 1% p.a. we also earn on a portion of these balances. There is even less incentive to participate in CPF Investment Schemes in this case.

As for the changes in the CPF Life Plans, that will only matter years later when we have to decide whether to receive lower, higher or increasing payouts. For now, our focus is to slowly build the CPF – SA over time and make sure we have a decent amount to work with by then.

CPF – MA

The purpose of our CPF – MA is for paying the premiums on medical insurance and hospitalisation expenses. The less we use it now, the more we have for later when we get older. Which is why the best way to manage our CPF – MA is to exercise regularly and have a healthy diet. It’s less financial management but more lifestyle management.

Besides, we earn interest of 4% p.a. on the CPF – MA balances and has a slightly bigger allocation of our monthly CPF contributions compared to the CPF – SA. This provides sufficient medical funding on top of the medical insurance we get at our jobs.

As you can see, we don’t view our CPF as just for retirement but instead as a financial planning tool that we try to utilise as working adults. In fact, our advice would be to understand how CPF can work for you the moment you start working full-time. The earlier you begin to manage your CPF, the more prepared you are for changes later on in life.