Wednesday, 14 September 2016

Feasibility of CPF Investment Scheme

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.
  • CPFIS - OA: 2.5% pa (i.e. interest you would have earned if you left your money in your CPF - OA)
  • CPFIS - SA: 4% pa (i.e. interest you would have earned if you left your money in your CPF - SA)
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.


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):
  • SPDR Straits Times Index ETF (ES3)
  • Nikko AM Singapore STI ETF (G3B)
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.

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.  

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