Should I invest my CPF OA?
We receive a lot of questions about why, given the government-guaranteed CPF Ordinary Account (OA) interest rate of 2.5%, anyone should take risk by investing their CPF money in the financial markets.
While the Singapore government's risk-free interest rate of 2.5% for your OA seems like a good idea, investing your CPF OA can amplify your return in the long run. For instance, by investing long-term on diversified, global portfolio with strategic asset allocation and cost management, a 20-year investment period has the potential to grant you a return of more than 50% in the best scenario.
In this article, we'll show you how we arrive at the above conclusion by putting the guaranteed 2.5% interest rate into context and thinking deeper about how markets and the economy can be utilized to grow your savings.
However, before doing anything, we'll also address why we bother taking risk at all, and how to be rewarded with returns for risks taken.
Grab a coffee. This is a long one, but try to make it to the end as we hope it leaves you with a framework to make better investment and financial planning decisions, especially using your CPF. But if you're a savvy CPF investor - jump straight to growing your wealth with us here.
How does Singapore's government determine the CPF OA rate?
As stated by the CPF Board, "OA monies earn either the legislated minimum interest of 2.5% per annum, or the 3-month average of major local banks' interest rates, whichever is higher. The OA interest rate will be maintained at 2.5% per annum from 1 October 2019 to 31 December 2019, as the computed rate of 0.64% for bank rates is lower than the legislated minimum interest rate."
We can say that the government is doing the retirement savings of the people of Singapore a service by paying 1.86% more than the 3-month average interest rate by the major local banks. When bank interest rates were higher, the OA rate was higher, reaching 4.69% as recently as 1991. Since the year 2000, as interest rates have come down, the OA rate has stayed at the minimum legislated amount
CPF OA rates versus stock and bond market returns
We compared CPF OA rates with the SGD returns of the MSCI All Country World Index (large-caps developed markets and emerging markets), MSCI World (large-caps developed markets only), S&P 500 (US large-caps) and Bloomberg Barclays Global Aggregate Bond Index (SGD-hedged) since 1990.
Understanding the return characteristics of different asset classes is important. One particularly important thing to consider is the success rate in beating the CPF OA interest by taking risk, and the amount of time you have to be invested to be reasonably certain of being successful.
In general, as we increase the length of time invested, the success rate in performing better than leaving your money in the CPF OA increases. If you invested in diversified global stocks (such as the MSCI ACWI), you can expect that for almost 80% of 10-year rolling periods you would have beaten the CPF OA by being invested. Over any 20 year period, that number goes up to 100% certainty (looking at historical data).
The longer your investment period, the better your success rate in generating higher return with investing CPF OA.
It's really about time. This makes a pretty compelling argument to take risk if you have a long enough investment horizon. That being said, you have to know yourself before doing so. Our behaviour and emotions often gets in the way of capturing long-term market returns.
In the chart below, pay particular attention to the worst outcomes for shorter time periods.
CPF OA investment returns versus stock and bonds, comparing short- and long-term investment periods
For the finance people reading this and thinking that the stock index numbers look low, please note that everything has been converted into SGD, while the industry typically shows these numbers in USD. The USD:SGD rate has moved from 1.87 in January 1990 to 1.38 in September 2019, a 36% appreciation over the time period. BBGA may also look high: this is because it is SGD-hedged, following institutional best practices when constructing a portfolio for you, a Singapore-based investor.
Key considerations before investing your CPF OA:
1. Consider your risk tolerance
Can you live with a 40%+ loss on your investment value and still stay invested? If not, then investing in 100% stocks is not a wise decision for any length of time, as those short-term shocks will knock you off course. Unfortunately trying to time your way around these sharp drops is not possible to do with any degree of certainty, so we advise a lower risk portfolio. If you invested in a globally diversified 60% stocks, 40% bonds portfolio ("60-40"), that max loss decreases to ~28%, but again, you need to be comfortable with riding out those shocks and taking this risk.
2. Decide which investment product to invest in.
A common concern is: generally, why do stocks compensate more than bonds, which compensate more than the CPF OA rate?
It is not random. It is structural. Stocks are legally and structurally riskier than bonds. In the case that a company goes bankrupt, the bondholders will be paid back before the company stockholders get anything. As a result, the market must generally compensate stockholders more for taking greater risk than the bondholders. And the market must generally compensate the bondholders more than risk-free products. In the finance biz, we call this the equity and credit risk premiums.
Read more about bonds: Bonds can be an essential part of your portfolio (Endowus Insights)
Can the government-guaranteed CPF OA rate exceed your CPF investment return? It's all relative.
We may think of the CPF OA rate as something just set by the government, but it too is alive. It too is moving with the market, inflation, and the return on assets. It is highly unlikely that the government will be able to afford to pay an interest rate on CPF OA that is higher than riskier capital market returns for a sustained period of time. The money has to come from somewhere.
Deflation (the ongoing decrease of the prices of goods and services) and hyperinflation (the rapid and out-of-control increase of the prices of goods and services, think Zimbabwe) aside, the relationship between risk and return should persist, and therefore returns of diversified stocks over bonds over the CPF OA rate should remain. Avoiding deflation and hyperinflation is in the interest of Singapore and its economic growth and relevance in the world. Monetary and fiscal policy is designed to avoid these scenarios.
What do all these numbers translate to in growing your savings?
Comparing the CPF OA guaranteed rate vs one's potential investment return
Let's say you invested $50,000 in the MSCI ACWI.
If you invested in Jan 1990, by Sep 2019, a period of almost 30 years, you would have $245,796, a 392% total return. Keeping your money in your CPF OA would be worth $115,176, a 130% total return.
Best 20 year case:
In the best 20 year period, which still went through the 2008 Global Financial Crisis, you would have $188,840, a 278% total return. Keeping your money in your CPF OA would be worth $85,931, a 72% total return.
Worst 20 year case:
In the worst 20 year period (you bought near the high of the dot-com boom in 1999, and sold at the depth of the flash crash at the end of 2018) you would have $96,989, a 94% total return. Keeping your money in your CPF OA would be worth $82,394, a 65% total return.
If you are unlucky, and do happen to catch the worst 20 year period, dollar-cost averaging often referred to as a regular savings plan (RSP), can give you a slightly better certainty of what your outcome will be. In the case of a $1,000 monthly investment subsequent to the $50,000 initial investment, you would have ended up with $488,091 if invested versus $390,816 if left in your CPF OA (on a total principal investment amount of $289,000).
It is obvious from this study that two things matter. Time in the market (how long your money is in the market for), and market timing. Unfortunately, timing the market is not possible to do consistently enough to beat the market with any certainty over the long-term, and usually results in missing out on returns.
- Raja Ampat and the rewards of time rather than timing (Endowus Insights)
- The worst market-timer can still be a good investor (The Business Times, contributed by Endowus)
How do we give ourselves a higher confidence in capturing returns?
1. Diversify globally
It is true that in recent history and the numbers represented in this study point to the S&P 500 as a generally superior way to have invested your money. While we do love the S&P 500 and it does make up a significant portion of the Endowus equities portfolios, it too can have extended periods of underperformance, such as a -9% total return in the entire decade of 2000 to 2009, which emerging markets were up 162%. We do not know what the future will bring and urge our clients to diversify globally, across all developed and emerging markets.
Read more: "Hindsight is 20/20": Why we should stick to consistent, global diversification (Endowus Insights)
2. Be strategic, not tactical
Strategic asset allocation means investing and rebalancing towards an asset allocation that fulfils your needs, ambitions, and future liabilities, while at a behavioural risk tolerance suitable for you. Tactical asset allocation is trying to beat the market by timing your entry and exit, and changing your asset allocation based on the way you or an ?xpert' sees the world. Unfortunately, tactical rarely works, with an average investor return of 1.9% over the last 20 years (JPM Asset Management - Guide to Markets Sep 2019), likely due to fees and active trading.
Read more: The very annoying efficient market hypothesis and how to beat it (Endowus Insights)
3. Manage your costs
A 1% difference in fees per year results in a 245% difference in returns after 30 years (assuming an 8% versus 7% annualised return after fees).
Read more: A guide to getting ripped off: a dictionary on unit trust fees (Endowus Insights)
4. Fight for fair fees
Make sure that your advisor or banker is not being paid trailer fees, or sales fees, or other hidden commissions. This would incentivise them to churn your portfolio based on what is "hot" and pays higher commissions rather than a strategic allocation based on your goals and risk tolerance.
Read more: Unit trust investing: What are trailer fees and how do they eat into your investment returns? (Endowus Insights)
Final thoughts: Should you invest your CPF OA in the future?
Based on the returns and volatility of returns of the CPF OA, MSCI ACWI, and a 60% stocks | 40% bonds portfolio since 1990, we ran Monte Carlo simulations 20 years into the future. In the image below, you can see the concentration of red and grey lines in the $300,000 to $500,000 range, and a few outliers far above and a few below the CPF OA black line.
20-year investment trajectory using a Monte Carlo simulation
Based on the returns and volatility of returns of the CPF OA, MSCI ACWI, and a 60% stocks | 40% bonds portfolio since 1990, we ran Monte Carlo simulations 20 years into the future. You can see the concentration of red and grey lines in the $300,000 to $500,000 range, and a few outliers far above and a few below the CPF OA black line.
Do we know what will happen to markets tomorrow, next month or next year? Anyone who claims to know is likely very overconfident. We live in a world where even Jamie Dimon, the billionaire CEO of JP Morgan, one of the world's biggest lenders, cannot call the direction of interest rates in the near-term.
The markets will do what they do. But before you do anything, you have to ask yourself one important question:
Do you think the world, with its population growth and technological innovation, will produce more goods and services 20 years from now?
If your answer is no, you should definitely keep your money in CPF while you have to, take it out of CPF as soon as your age allows, then spend all your money on a lifetime supply of canned food and bottled water.
If your answer is yes, you should be using your CPF to invest. Find a way to participate in global markets. More goods and services = higher wages, more spending, growing companies, increasing asset prices, innovation and better efficiency in products and services, and an increasing stock market over the long-term.
Be patient. Be humble. Be invested.
One more chart for you:
The below graphs show the cumulative return of the MSCI ACWI and 60-40 over the CPF OA for every starting month since January 1990. As you can see, as you move from 12 months rolling to longer time periods, the red decreases and the blue grows.
And whenever you're ready to invest your CPF, we'll be here for you.