Why we need to invest our CPF savings to build future wealth

This article first appeared in The Business Times. 

The impending changes to the Central Provident Fund (CPF), recently announced in the Budget, have caused quite a stir. Through all the debate and discussion, it’s important to remember that CPF is a tool that every Singaporean should personalise and take advantage of.

It is a critically important resource that members can control to effectively grow their personal savings and wealth, whether through the CPF Investment Scheme (CPFIS), or later through CPF Life. 

Investing is an important aspect of securing the financial future of individuals and their loved ones. And investing through the CPFIS is an increasingly important way to build a bigger nest egg – whether through safer and less risky instruments such as Treasury bills (T-bills); or fixed-income funds that offer higher interest rates comparable to the Special Account (SA) interest rate; or through more risky investments in equities; or longer-duration fixed income to grow wealth through compounding.

Investing comes with its risk, which is defined by volatility of returns or, put differently, the unpredictability of outcomes of investing. 

We should ask to be compensated in the form of returns according to the amount of risk that we take. This is an important concept most individual investors do not get. Let me explain. 

Many people take too much risk when it comes to investing because they invest in things they do not know enough about — such as a friend’s stock tip, or crypto that has no intrinsic value. You take too much risk and not only do you not get compensated in the form of returns for taking that risk, you actually get negative returns and lose money. 

Commensurate returns

This is not how it should be. At Endowus, we advise our clients to only take the appropriate risk to generate the returns you need to achieve your investment objective or goal. 

This goal-based or liabilities-driven investing is how global sovereign wealth funds, pension funds, and college endowments invest — this is the institutional way of investing. As risk and return are correlated, if you take a certain amount of risk, one should expect to get the return that is suitable for the risk you are taking. 

The other extreme is when you do not take any risk or you take very little risk, and still expect something in return. CPF is the only system in which you take no risk and get decent returns, which is why individuals should take advantage of this. Over the long term, we have to question whether the CPF interest rates are even sustainable.

Many people have invested in T-bills thinking the 3 or 4 per cent returns are actually not bad. That may have been true when interest rates were near zero or 1 per cent, and inflation was barely above 2 per cent. However, with inflation higher for longer, the real return (the nominal return minus the inflation rate) of these CPF rates or T-bills is not what it seems.

Taking on no risk effectively means no returns in real terms (net of inflation). What is more real than inflation eating away at your purchasing power, as everything becomes more expensive in Singapore and your money just doesn’t get you very far? We need to do better.

The higher-than-market rates of CPF and the guaranteed nature of that return can lull people into a false sense of security. That can be said about the T-bills and fixed deposits people invest their Ordinary Account (OA) savings into as well – and especially so, because the rates fluctuate and interest rates are a function of inflation levels. When inflation is high, nominal interest rates are higher, and when inflation falls, interest rates come back down again.

While people are scared to invest in bonds and stocks due to their unpredictability, research shows that such risk becomes more manageable with a longer investment horizon, and reduces to a narrower band of outcomes that is closer to the long-term average returns of markets.

The long-term average returns of various broad global indices range between 7 and 10 per cent per annum over many decades. In other words, the longer you invest, the lower the risk that you lose money, or reap a return lower than the long-term average.

This is evidence that taking risk over the long term works, and you will be compensated for that risk if you choose to invest in globally diversified portfolios that manage it well. Time will do the rest by reducing the risk or volatility of returns.

However, time will work against you when it comes to the “other risk”. I’m referring to the bigger and growing problem of not having enough to live on as we get older. As we age, time works against us and exacerbates the risk of depleting our resources, especially if we do not invest our money to compound our returns over the long term.

Better outcomes

The risk of not having enough money to sustain our quality of living becomes exacerbated due to the rising cost of living and Singaporeans living for longer. Imagine: After working hard all your life, you realise you do not have enough saved up or to live on for the rest of your life. This “longevity” risk becomes not only more urgent, but also more prevalent. 

Now, people still have a lot of trouble putting those things together — CPF and investing. However, this is not a new phenomenon. We think back to the 2015 CPF Advisory Panel’s report that included the suggestion for a greater amount of CPF monies to be invested for retirement, through the recommendation for a lifetime retirement investment scheme. 

Comments followed from current Singapore President Tharman, back when he was Deputy Prime Minister in 2016, calling on younger Singaporeans to take “calculated risk” to generate higher returns using the CPF-IS. At the time, Tharman called the CPF-IS “not fit for purpose” due to the high cost of investment, lack of good investment options, such as passive low cost index funds, and the general lack of good advice and difficulty of even opening accounts. 

However, it is now approaching a decade since the CPF Advisory Panel was set up in 2014 and the landscape of investing has fundamentally changed in the CPF-IS, with the ability to open your CPF Investment Account digitally through any of the three domestic banks. 

Endowus became the first and only digital advisor for CPF investing in 2019 and has grown the pie of CPF-IS through the years. We have fund management companies like Amundi working with Endowus to bring the lowest cost index funds to ever exist in Singapore at just 0.05% annual management fees. 

This transformative digital progress now allows Singaporeans to seamlessly invest in, not only T-bills, but advanced institutional funds and portfolios fully digitally in an app. 

Using the various CPF programs – whether that be CPF-IS to maximise our potential future return, or CPF LIFE for annuity – is not only an important, but necessary, way to achieve a better outcome in one’s financial planning for the future. 

The CPF-IS has finally come of age and is now fit for purpose to help all Singaporeans to take on calculated risks to achieve long term success that allows greater compounding of returns. This will help to create a meaningful and sizable nest egg that will last a lifetime and beyond for all individuals. 

The employment contribution limit on CPF is $37,740 each year. On top of that, you can also save an additional $15,300 to your Supplementary Retirement Scheme (SRS) each year and enjoy tax relief of a total of $53,040. If you are a foreigner, you can also enjoy a higher yearly contribution of $35,700 for SRS.

Below 55, you can still invest a meaningful sum in both your OA and SA that can be invested through a regular saving plan into globally diversified, low cost portfolios that will help achieve success by compounding returns over the long term.  Even beyond 55, your OA is an important vehicle through which you should maintain as large a balance as possible so that you can invest for the remainder of your life – 30 to 40 years on average – to make sure that you do not run out of money, and even have enough to leave some behind for your loved ones. 

‍Samuel Rhee, Chairman and Chief Investment Officer at Endowus, also serves as a member of the World Economic Forum Longevity Economy Steering Committee.