My last two blogs was about investing for the long run. Specifically, in Blog #36, I showed how easy it is to be your own robo-advisor using nothing more than Excel and an add-on software to simulate and visualize investment outcomes. The example in that blog simulates the terminal wealth distribution of a “glide path” over a 35 year period based on a stock-bond portfolio where the allocation to stocks declines as the investor ages. This investment approach focuses on long term results and prudent risk management. It goes by the name of lifetime asset allocation.
Some readers wrote in asking whether they can utilize their CPF savings to do lifetime asset allocation. My short answer: why not? But I also added a caveat: there are traps to be aware of. This blog will offer advice on how to avoid these traps.
To begin with, there are two CPF investment schemes through which you can invest your CPF savings. The first and older scheme is the CPFIS or CPF Investment Scheme. The newer scheme is the LRIS (Lifetime Retirement Investment Scheme). I will focus on the CPFIS in this blog.
The CPFIS allows CPF members to invest their OA (Ordinary Account) and SA (Special Account) savings in a range of assets. The list of assets is rather long, but the most popular asset classes for OA investments are bonds, stocks, exchange traded funds, gold and unit trusts. SA savings can be invested in a narrower range of securities such as Singapore Government bonds and lower-risk unit trusts (e.g., balanced and bond funds). Click this link for more details.
Two key points to note about the CPFIS
- You are restricted from investing the first $20,000 in your OA and the first $40,000 in your SA. Money in these restricted accounts earn 1% more interest than the usual 2.5% interest on the OA and 4% on the SA. In other words, the first $20,000 in your OA earns interest of 3.5% and the first $40,000 in your SA earns 5%.
- The CPFIS implictly assumes that you have the knowledge or time to look through a large number of investment choices. This can be a daunting task. Looking at unit trusts alone, there are well over a hundred bond, equity and balanced (mixed) funds under the CPFIS! And this doesn’t count investment-linked policies (ILPs) which are life insurance policies where you can invest some of the premiums to unit trusts managed by the insurer.
Advice for CPFIS Investors
- The OA pays good interest (2.5% – 3.5%) for something that is basically risk-free, and the SA pays even better interest. If I were you, I would leave my SA untouched to earn the 4%-5% risk-free return, viewing my SA account as the bond portion of my overall portfolio. That leaves the OA. I do invest some of my OA savings with the hope of beating the 2.5% OA interest rate.
- The next question is: what to invest your OA savings in? Since equities have higher average returns than bonds over the long run, it doesn’t make sense to invest your OA savings in bonds. Stocks are a better choice.
- As always, diversification is a prudent thing to do whether you are investing your CPF or private savings. There are two ways to invest in stocks in a diversified manner: (1) invest in a passively managed exchange traded fund (ETF) such as the iShares MSCI World ETF and (2) invest in an actively managed equity-focused unit trust. There are dozens of ETFs listed on the SGX, some of which track a single market index while others track regional and global stock indices. There are close to a hundred equity and balanced unit trusts under the CPFIS to choose from. Visit this website to view their historical performance.
- ETF or unit trust? An ETF is passively managed. It simply follows an index and gives nearly the same return of that index. In contrast, a unit trust manager tries to beat the index that best mirrors his portfolio (the benchmark). There is no guarantee he or she will achieve this goal. In fact, research shows that active funds are generally outperformed by their benchmark, not the other way around! A gamble is defined as an investment with negative returns on average. Relative to ETFs, a unit trust investment resembles a gamble.
- Even if a unit trust has the same gross return as an ETF, the unit trust investor will always lose to the ETF investor after fees. This is because unit trusts typically charge higher fees that comprise a front-end fee and an annual expense ratio (primarily the management fee). ETFs do not charge front-end fees. Moreover, the expense ratios for ETFs are much lower than those of unit trusts. For example, the iShares World ETF charges an annual expense ratio of just 0.24% per annum. The expense ratio for the popular SPDR S&P 500 ETF is a mere 0.095%. Expense ratios for unit trusts on the CPF “A-list” (better performing funds) are capped at 1.75% for funds classified as high-risk (these are equity funds), 1.55% for medium-to-high risk (balanced) funds, 0.95% lower-to-medium risk (bond) funds and 0.35% for lower-risk (cash) funds. Thus, the cheapest A-list unit trust is still more expensive than a broadly diversified equity ETF! In addition, the front-end fee for CPFIS funds can be as high as 3%. This means that for every $10,000 you invest, only $9,700 is actually invested. Front-end fee and expense ratio are performance killers which an ETF investor largely avoids.
- Finally, there are dumb ways and smart ways to invest in unit trusts. Dumb investors like to chase recent “hot funds”, usually to their detriment because performance consistency isn’t a trait of active fund management. This is why you often see top-quartile funds in one season falling to the bottom rack the next season. Dumb investors also tend to change funds as frequently as they change clothes. This is called churning. If you have no crystal ball (and most retail investors don’t), churning will only lead to higher costs with no assurance of higher returns. In September 2016, Deputy Prime Minister Tharman Shanmugaratnam pointed out that over the last 10 years, more than 80% (!) of those who invested through the CPFIS would have been better off leaving their money in the Ordinary Account. I suspect churning is a major reason for this dreadful result (the other reason could be the poor performance of the underlying funds).