Finance Smiths

Personal finance apprentices-in-training

No CPF Investment Scheme and Margin Loan for us

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This is likely to be my last daily post in this series for a while as I prepare for my return to work tomorrow. It’s been a good experience and as I spend the day resting at home today, I realised it’s time for me to head back to the office. My wife and confinement nanny have settled into a daily routine with the baby that requires less and less of my involvement.

Which should be the case since they will be managing the household more now that I’m going back to work. While I enjoy the time spent with my wife and the baby, I like having my own activities as well. And my job is a big part of that. I like the work that I do. It’s knowledge-based, requires analytical skills & critical thinking and I get to deal with interesting stakeholders.

Always remember, the test for whether your job is knowledge-based is how long it takes for a new person to replicate what you can do and how well he/she can do it.

While I was in a toxic work environment in my previous job, my current job’s work environment is much better. Something my wife appreciates a lot since I was complaining to her so much about the problems & issues I was facing in my previous job.

I know my wife enjoys aspects of her job too. She is starting to get bored just being at home with the baby and confinement nanny. I reckon she will start to head out soon to catch up with colleagues and friends. Social and professional engagement is important to her too.

My wife’s job is less knowledge-based and requires less analytical skills & critical thinking. However, it requires a specialised skill set, which explains why she can draw a much higher pay than me. But over the long term, knowledge-based jobs are less likely to be outsourced and as I accumulate more knowledge, the pay is more likely to climb faster than my wife’s.

While my wife is aware that her job is at a higher risk of being outsourced, it’s possible for her to pivot into a more knowledge-based job. The only thing is that it is difficult for her to pull this off when she just had the baby. A lateral move in her company makes the most sense since another company will not pay her the same salary to learn new skills.

It becomes a race against time. Understanding our limitations & capabilities, the job risks we face and balancing that against making career moves that pay off. Our ability to manage this trade-off will decide how well or badly we do in our career.

Anyway, I got side-tracked by the discussion on jobs. It always happens because there’s so many things to be aware of, careful about and to do with them. As we try to accelerate the growth of our retirement funds and investments, my attention turned to these common things that people do.

  1. Invest CPF savings
  2. Use margin loan to invest

CPF Investment Scheme

Even after setting aside $20,000 in our CPF-OA and $40,000 in our CPF-SA separately, we have about a combined $60,000 of CPF-OA and CPF-SA each to invest under the CPF Investment Scheme. That’s about $120,000 in total for the both of us.

When we looked through the investment products available (different for CPF-OA and CPF-SA), the CPF-SA investment products don’t appeal to us. Might as well leave the balances inside CPF to get the 5% interest on the first $40,000 and 4% interest on the remaining balance.

The CPF-OA investment products are good and long-term investing in stocks, REITs & stock ETFs could potentially yield higher returns than the 3.5% interest on the first $20,000 and 2.5% interest on the remaining balance. As tempting as it is, we are inclined to leave our CPF-OA and CPF-SA balances as is for now.

They grow slowly but steadily every year and it’s nice to know we have retirement funds that are not share market performance driven. As long as there are monthly CPF contributions, the risk of it not growing is minimal. Speeding up its growth has risks and just not worth the reward at this time. There’s something about being sure, slow and steady that appeals to us.

Margin Loan

This involves borrowing money to invest in shares and using the shares as security. Honestly, when I first heard about this type of loan facility, I was shell-shocked by it. Great for banks and brokerages to earn profits from but very bad for investors. Because a margin loan is incredibly difficult to be utilised well by an average investor in the long run.

While a margin loan can multiply gains if the market goes in your favour, it can also amplify losses if the market goes against you. Unless you are so consistent at making profits from the market and adept at managing your investing psychology, an average investor is going to be burnt badly by a margin loan. Yet it does not seem to stop people from drawing on them.

It doesn’t matter how much we want to achieve financial independence. We refuse to accelerate our investments growth by using high-risk financial tools. Impatience can cost us so much more than the reward from being patient. We are going to take our time with this and enjoy the process.

Are my parents ready for retirement?

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I read an interesting post from this US personal finance blogger (Broke Millennial) – Are You Your Parent’s Retirement Plan? It sets out conversation topics on insurance, retirement funds, mortgage and debt that adult children can consider having with their parents to better understand their retirement plans.

This got me thinking about my parent’s retirement plans and whether they are financially fit for retirement. I have had conversations with my parents about this before to see where I can assist them in their financial planning for retirement.

We usually end up discussing the sufficiency of the CPF Life payouts after taking into account the other factors of insurance, active & passive income and debt. That might be how I will write this post for a more complete financial analysis of my parents’ retirement plans.

1. Insurance

My parents have health insurance plans that cover for hospital and surgical expenses. Although these health insurance plans are not the most comprehensive, the annual premiums to be deducted from their Central Provident Fund (CPF) – Medisave Account (MA) are quite high due to their age (60+).

In fact, the annual premiums are expected to increase as my parents get older and my siblings & I might have to top up their CPF – MAs or have the withdrawals come from our CPF – MAs instead. Medical costs from hospitalisations and emergencies can be a significant drain on the family finances when not managed well. My parents are relatively healthy for now due to their active lifestyles but we will continue to budget for their medical expenses.

My parents used to have term life insurance policies but they have since expired. I’m not sure how useful life insurance policies will be for my parents now that they no longer have any dependants. My siblings & I can take care of ourselves and will look after them financially as well.

2. Active Income

My dad stopped working a few years ago and has since moved to Malaysia. He built a house on top of a small piece of family farmland that we have and grows a variety of fruits & vegetables while rearing a few chickens. He also catches fish from the farm drainage canals and ponds when there is heavy rain.

Having lived for a number of years on a farm in Malaysia when he was young, my dad really likes this lifestyle and I’m glad he gets to enjoy it in his retirement. Although my dad no longer has any active income, his expenses are low since he only spends on necessities (i.e. items that he can’t grow on the farm like rice and other meat produce).

Since the cost of living in Malaysia is much lower than Singapore and my dad is a lot happier and healthier from the manual labour tending to the farm, his expenses have gone down over the years. He comes out to Singapore to visit us or we go in to Malaysia to stay with him on the farm once in a while.

My mum works as a retail promoter a few days each week and is paid monthly based on the number of hours worked. It’s not a strenuous job and she gets to interact with her colleagues and customers. The active income helps to pay for the travel trips my mum goes on with us or her friends.

I have to admit that this is not a normal or common living arrangement for most families out there. However, it has worked out well for my parents because both of them get to enjoy doing the things they like. This is especially so when you have adult children living their own lives so everyone gets to spend quality time with each other when we get together.

3. Passive Income

My parents own a residential apartment in Malaysia that is about to be completed and leased out. Since they did not take out a mortgage to pay for the apartment and had enough cash to purchase it, the rental income net of rental expenses will constitute passive income to sustain my dad’s lifestyle on top of their savings in Malaysia.

If money gets tight due to unforeseen circumstances, my mum can rent out a room in the family apartment in Singapore (where the housing loan has been paid off) for additional rental income on top of their savings in Singapore.

Since my parents do not have an investment portfolio of equities and bonds, they rely a lot on the CPF Life payouts as their main source of passive income. I never realised the importance of CPF Life until I see its payouts sustaining my parent’s retirement.

Even though my siblings & I make monthly contributions to my parents and manage their living expenses, these CPF Life payouts provide a strong layer of support. It’s usually the dual impact of reduced income and increased expenses that cause financial problems in retirement. Hence the need to find ways to maintain the income while reducing expenses.

4. Debt

This section is going to be short because one of the best things my parents have done financially is not to have any type of debt in retirement. No mortgage, no student loan and no credit card debt.

Although my parents did not manage to build an investment portfolio of shares and bonds, they have put themselves in a strong financial position to retire by managing their income and expenses. Their lifestyle does not consist of luxury spending but they get to enjoy doing the activities that make them happy. That’s all I can ask and wish for in my parent’s retirement.

Which retirement scheme do I prefer?

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In my previous post, I gave an overview of my Superannuation in Australia and Central Provident Fund (CPF) in Singapore. This post will be about my personal opinion on which retirement scheme I prefer. It’s important to note that Superannuation and CPF serve as retirement funds in Australia and Singapore respectively where the cost of living, tax rates, lifestyle etc are different.

It can be difficult to compare these two retirement schemes on a level playing field. This comparison might not be fair but it will be based on my experience and views. At the very least, isn’t it interesting to read about how different retirement schemes measure up against each other?

Employer Contributions 

The purpose of retirement schemes is to provide you with income in retirement. The more funds you have in the retirement schemes, the more income you will receive when you retire and stop working. Employer contributions can go a long way in building up these funds especially when you can’t make as much employee contributions.

The current employer contribution rate is 9.5% for Superannuation and 17% for CPF. However, there is a monthly Ordinary Wage (OW) ceiling cap of S$6,000 for CPF i.e. the employer only needs to contribute 17% of your monthly salary up to S$6,000. The employer does not need to contribute 17% of your excess salary above S$6,000. I don’t think there’s such a cap on employer contributions for Superannuation.

This probably only makes a difference when you are a high income earner in Australia or Singapore. Given I have only been working for a few years in each country, this point goes to CPF for me since I had more employer contributions on an average salary.

Employee Contributions

There is no mandatory employee contribution for Superannuation but the mandatory employee contribution rate for CPF is 20%. I like how the Singapore Government is essentially forcing each employee to save for his/her retirement by contributing to the CPF. It might not be a bad idea since I chose not to make any contributions to my Superannuation.

However, it would be nice to have the choice of my employee contribution rate to CPF. After all, I might decide that having the cash on hand is more useful at the start of my career when I am anticipating future significant expenses. Although I agree that the Government should encourage employees to contribute to their CPF, I don’t agree with the current paternalistic approach to mandate a rate of 20%, which is even higher than the employer contribution rate. This point goes to Superannuation for me.

Flexibility of use

Superannuation can be used to cover life, disability, and income protection insurance premiums but there are not many other uses. CPF can be used for a variety of purposes – housing, investment, education, insurance and medical expenses. By allowing for greater flexibility in using CPF, this offsets the disadvantage of me having to make mandatory contributions to CPF.

Although you could make an argument that having so many uses for CPF detracts from its main purpose as a retirement fund scheme, it does come down to how you manage your CPF.

Superannuation is difficult to understand at the start but easy to manage once you get the hang of it. Once you start working after graduation and select a superannuation fund, ensure that the investment option is balanced or aggressive and the monthly contributions will take care of the rest.

The problem with CPF is that you really have to monitor how much of the OA you are using for housing, how much you can contribute to the SA and how much MA you have left for medical expenses.

Nevertheless, this point goes to CPF for me because it’s better to have more options of use for the retirement fund schemes. After all, you can always decide not to use your CPF for anything and just allow the balances to build up.

Growth of funds

This one is tricky. Superannuation works by dollar cost averaging into the units of a fund on a balanced or aggressive investment option i.e. growth by exposure to equities. You could replicate this by using the CPF Investment Scheme, which allows you to invest your OA and SA in a wide range of investments to enhance your retirement funds.

Both schemes require you to not attempt market timing by changing the investment options for Superannuation funds or buying & selling the investments for the CPF Investment Scheme.

I guess where CPF takes the point for this is that the interest rate on the SA can reach 4% to 5%. Even by not using the CPF Investment Scheme, effective utilisation of the SA can enable your retirement funds to build up quickly over time without taking on much risk.

Fees

Superannuation funds charge fees for maintaining your retirement balances and CPF don’t charge fees for the same service (unless you are using the CPF Investment Scheme). You could argue that Superannuation funds have to execute more monthly transactions (i.e. buying and selling of units) to justify the fees.

After all, CPF doesn’t have as many monthly transactions since interest only gets paid at the end of the calendar year. You do have withdrawals for other purposes such as housing and insurance but those can be automated and require less monitoring.

My view is that fees eat into the returns of all funds and CPF takes the point for charging little to no fees.

Access at retirement

This generally refers to when and how you can access the Superannuation or CPF. The conditions of access can be complex for both Superannuation and CPF. For a simple comparison, Superannuation can be fully accessed at age 60 but CPF can be partially accessed at age 55 and fully accessed at age 65. More importantly, the entire amount of Superannuation can be withdrawn but CPF can only be withdrawn as a monthly payout once you hit the preservation age.

FYI, my view is that the preservation age for retirement schemes in most countries are likely to get higher over time. I would think this applies to both Superannuation and CPF i.e. I have no idea how old I would have to be to access my retirement funds.

As much as I think it’s a good idea not to allow for retirees to withdraw the entire amount of CPF at one time, this should be a choice that they have. Again, I don’t agree with the paternalistic approach that the Singapore Government has taken on restricting retirees’ access to their own retirement funds. Hence, point to Superannuation for me. It might be a better approach for more personal finance education in schools and companies to empower everyone with the ability to make good financial decisions.

Conclusion

I must emphasize that you could reach a different conclusion even after assessing the same factors. In my case, I find that CPF is my preferred retirement scheme. It allows for me to build up retirement funds quickly from higher employer and employee contributions. This is especially effective when I have not been working in Singapore for the initial few years of my career. CPF also gives me more options in utilising the funds for other purposes and I find the flexibility useful as long as I have the self-discipline and knowledge to manage this.