The CPF Advisory Panel announced two new initiatives last week.
One of the two initiatives is the new CPF Escalating Life Payout Plan, a CPF Life option that allows Singaporeans to opt for a monthly payout that increases by 2% each year. You can read more about our thoughts on it in this article.
The other major initiative is one that could potentially be a game changer for Singaporeans. The advisory panel recommended the setting up of a "Lifetime Retirement Investment Scheme".
This Lifetime Retirement Investment Scheme (LRIS) is an option for Singaporeans to invest their CPF monies in diversified low-cost funds. This enables them to obtain higher expected returns for their CPF monies by investing in funds that are likely to be involved with equities and bonds.
So what does this mean for us average Singaporeans? Is this LRIS worth investing in?
The Story Thus Far…
Singaporeans earn a risk-free interest rate starting from 2.5% for their money in the CPF Ordinary Account (CPFOA) and 4% from their CPF Special Account (CPFSA).
Those who want to earn higher returns have the option of investing in products such as stocks, unit trusts (UT) and investment-linked policies (ILPs).
However, more often than not, Singaporeans who invest their CPF monies make losses. Members would have been better off leaving their monies untouched and earn the risk-free interest rate instead.
Read Also: Why Investing Your CPF Money Is A Bad Idea
In other words, Singaporeans were caught in two places. They can leave their monies untouched and earn an acceptable interest rate, or try investing it with their (limited) knowledge and be part of the 85% who would have been better off not doing anything.
The "High Cost" Of Deploying CPF Money For Investment
There are a couple of reasons why it is costly to deploy CPF money for investing.
# 1 The Opportunity Cost
CPF pays a risk-free rate from 2.5% for OA and 4% for SA. This means that anyone investing their CPF monies would be forgoing this guaranteed return in the hopes that he or she can make higher returns elsewhere from their investments.
# 2 Transaction Cost
Transaction cost is an important area of investment that most people don't recognise.
When you invest in products, there is always a transaction cost involved. For example, buying a unit trust means paying an annual fund management fee regardless of how well the unit trust performs. This eats into your returns or increases the losses you are already facing.
The thing about earning risk-free CPF returns is that there is no transaction cost involved. You don't need to pay a fee to financial institutions or agents for that service.
Read Also: CPF Outperform Market Indexes In 2015
How The CPF Lifetime Investment Scheme Hopes To Help People
We obtained some information from a Mercer report issued. Mercer was an independent consultant engaged to study the feasibility of this scheme.
Provide Investment Options At A Low Cost
The LRIS hope to provide investment options at a low management fee of about 0.5% per annum. This is in contrast to many funds out there that typically charge about 1.5% per annum.
A difference of 1% may not seem like much. Yet when compounded over a longer period of time (i.e. 30 years), this could add up to a lot of money.
Here is an illustration.
| ||LRIS Fund||Typical Retail Fund|
|Total Returns After 30Years||$416,800||$349,800|
Given the same returns assumed (6.8%), we can see that a higher management charge takes away about $67,000 from our retirement.
That is almost 14 years worth of investment contribution! This figure also excludes any sales charges (about 3%) that retail funds may also charge.
We are not saying that you should stop investing in retail funds, or any other investments that you think makes sense for you.
Rather, the point to remember is that any actively managed fund or investment would not only need to outperform the LRIS funds but also beat it by a margin that justifies the higher charges over the long run.
Average Return You Can Expect From The LRIS Fund?
Since the LRIS fund is not yet constructed, and would take years before we even know what the average returns end up to be, Mercer provided some guidance on what the expectations could be.
Here are some observations that we have.
Higher Return For Higher Risk
For example, we can see from the table above that the expected return from the Life-Cycle Fund is 6.5%, compared to a 5.2% return from the CPFSA and 3.0% from the CPFOA.
This makes sense since CPF members who opt for it would be taking on greater risk and hence be compensated with higher expected returns.
Probability Of Fund Underperforming
The risk members take is the possibility that they might have been better of leaving their CPF monies untouched in the CPF account.
The table below shows a risk/reward illustration.
We can see the icons shaded in blue (OA rates) show a much lesser probability of underperforming against CPF while providing a higher expected return in CPF balances.
This is not surprising since the OA interest rate is lower compared to the SA. Logically, it makes more sense to invest your OA monies in the future while leaving your SA untouched.
When the investment horizon increases, the chance of the Life-Cycle Fund underperforming also decreases.
Why Singaporeans Have Reasons To Be Excited Over The LRIS
In the past, Singaporeans would either need to be savvy stock investors or pay high charges to make investments with their CPF monies in the hopes of earning higher returns.
This did not always pan out well because 1) lots of people are just not that great in picking stocks and 2) management fee charged by professional fund managers eroded their returns over the long run.
With the LRIS, Singaporeans now have access to a few low-fee funds that they can consider investing in to earn higher returns.
Financial Education Is Still Important
That being said, we think it's important to stress that the funds offered within the LRIS are not risk-free. Mercer estimated that there is a 5% chance that members would see their account balances falling by more than 20% in the first year.
We must remember that just because the CPF board has introduced the LRIS as an option doesn't mean that everyone in Singapore should just put all their investable CPF monies into it.
As responsible adults, we should ensure that our money is invested in a way that reflects our risk appetite.
Ultimately the LRIS, once introduced, is an additional option provided by CPF for its members. As with all investments, it does carry some risks that members should understand and be familiar with.
Investing in the LRIS does not excuse one from educating oneself about financial planning and risk management.
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