Why investing (or not investing) your CPF is important

When planning for our retirement in Singapore, we cannot ignore the CPF system.

In a nutshell, the CPF system safeguards our basic retirement adequacy by providing us with a stable income for as long as we live, once we are no longer in the workforce in our golden years.

HOW THE CPF SYSTEM SAFEGUARDS OUR RETIREMENT 

During our working years, we contribute a fixed proportion of our salary to our CPF accounts - Ordinary Account, Special Account and MediSave Account.

While we build this nest egg through the years, we are paid interest on our balances:

• Ordinary Account (OA): 2.5 per cent per annum (p.a.)
• Special Account (SA): 4.0 per cent p.a.
• MediSave Account (MA): 4.0 per cent p.a.

In our retirement, we will be able to tap on part of our CPF balances to receive a lifelong monthly payout via the CPF LIFE scheme.

However, we may be able to boost our retirement nest egg by investing our CPF Ordinary Account and CPF Special Account balances. Before investing, we also need to know that we can only invest anything above the first $20,000 in our CPF Ordinary Account and the first $40,000 in our Special Account.

TO INVEST OR NOT TO INVEST? UNFORTUNATELY, THAT'S NOT A QUESTION WE TYPICALLY ASK 

Despite being able to invest our CPF OA and CPF SA balances, this is not a topic many of us think about. According to CPF, there are 3.9 million CPF members, with a combined $391.1 billion in their CPF accounts.

However, as at the end of December 2018, there were about 940,000 people who invested a combined total of approximately $17.4 million of their CPF Ordinary Account balances and about 310,000 people who invested a combined total of approximately $5.1 million their CPF Special Account.

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Even though only a fraction of us are investing our CPF balances, the decision to invest (or not to invest), should be a decision - and not we do because someone has sold us a product offered on the CPF Investment Scheme (CPFIS) or because we aren't aware such a strategy event exists.

When considering to invest our CPF OA and/or SA balances via the CPFIS, there are key pros and cons we need to know.

WHY INVESTING YOUR CPF IS IMPORTANT

#1 Grow your retirement funds by more than the base interest rate

As stated above, funds in our CPF OA earns 2.5 per cent p.a., while funds in our CPF SA earns 4.0 per cent p.a. To grow our retirement nest egg to a bigger and more comfortable amount, we can either transfer our CPF OA to your CPF SA, to earn an extra 1.5 per cent p.a., or we can choose to invest one or both our CPF OA and CPF SA.

For some perspective, the average 3-year annualised returns on unit trusts and ILPs we can invest in via the CPFIS is 7.88 per cent. This is much better than the 2.5 per cent p.a. we earn on our CPF OA balances, and also better than transferring our CPF OA balances to our CPF SA to earn 4.0 per cent p.a.

Of course, we can also see that the 1-year return is just 2.21 per cent, which we will discuss more in the disadvantages segment below.

#2 Retaining the flexibility to return funds to your CPF Ordinary Account

When we invest our CPF Ordinary Account balances, we can sell them off to channel the money back into the account.

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However, if we choose to transfer our CPF Ordinary Account balances to our CPF Special Account to earn a better base interest rate, we will not be able to refund our CPF Ordinary Account.

This can be important if we wish to grow our funds but retain the flexibility of returning funds back into our CPF Ordinary Account in unforeseen circumstances, especially when we are unable to keep up mortgage payments if we lose our salary because of retrenchment, becoming injured or are diagnosed with a critical illness.

#3 Protecting your CPF Ordinary Account when you buy a home

Firstly, this has nothing to do with the returns you are receiving.

If you wish to protect our CPF Ordinary Account balances when buying a home, we can use this strategy to ultimately retain more than $20,000 in our CPF Ordinary Account.

Just consider this scenario, if we have $100,000 in our CPF Ordinary Account, and we wish to purchase a home for $400,000, we can only leave up to $20,000 in your CPF Ordinary Account under the current rules.

By investing $40,000 of our CPF Ordinary Account balances, we can choose to contribute only $40,000 to your home down payment. After paying for the down payment, we can sell the investments, and channel back the $40,000 to our CPF Ordinary Account, to retain up to $60,000 rather than the $20,000 we originally could retain. This can be used to pay for our home loan in emergencies or by choice.

WHY NOT INVESTING YOUR CPF IS IMPORTANT 

#1 Understanding that returns are not guaranteed

While we may be able to substantially boost our retirement nest egg in the long-term by compounding our funds at a higher interest rate, this is not guaranteed.

In the table above, we saw that the average 1-year returns on unit trusts and ILPs we can invest in via the CPFIS is 2.21 per cent. This is obviously lower than the 2.5 per cent p.a. we can earn on our CPF OA balances.

We need to understand that when we invest in anything, we are taking a risk. While that risk may pay off in the long term, we may face some volatility in the short term by earning a lower interest return or even face losses.

While we have a good chance of outperforming the CPF base interest rates if we invest over the long-term, there is no guarantee of that either.

#2 If you have important short-term goals

Investing our CPF monies should be for long-term goals such as boosting our retirement nest egg.

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If we have short-term goals such as funding our child's education or buying a home, we may not be able to take much risks with our CPF balances. This is because we cannot afford to see our investments shrink with an important upcoming expense.

Many studies have also shown that while our investments should grow in the long-term, very few people can predict what will happen in the short term. We need to ask ourself if we can withstand an economic crisis that may see our investments halve in value.

YOU NEED TO UNDERSTAND WHY YOU ARE INVESTING OR NOT INVESTING YOUR CPF 

We need to give ourselves the best chance to grow our retirement funds, and the earlier we start, the better our chances of achieving a better outcome. By investing our CPF balances, we may be able to earn a higher interest return than the base CPF rates over the long-term and boost our retirement funds.

At the same time, we should not blindly jump into any investments, regardless of what anyone tells us. It may be better to stay out of even the most lucrative investment if we don't fully understand what we are doing.

Investing or not investing should be a decision, rather than being sold a product or being ignorant of such an opportunity.

This article was first published in Dollars and Sense. All content is displayed for general information purposes only and does not constitute professional financial advice.