The Lifetime Retirement Investment Scheme (LRIS) provides another avenue for CPF members to invest their OA and SA savings. At the time of writing, this scheme is not in operation but soon will be.
LRIS is meant to simplify investment choice for CPF members. Although the CPFIS has good intentions (to provide members with a wider range of investment options), the take-up rate under this scheme has been dismal. For example, as of Q3, 2017, 1,252,000 members were CPFIS investors. Their total investment amounted to only $22 billion, a paltry sum compared to the aggregate OA and SA balance of $215 billion. Thus, many members prefer to leave their money with the CPF Board than invest it for higher returns. This is a pity because properly invested, CPF savings can be a valuable source of retirement income. In particular, asset classes like equities provide higher average returns than cash, a low-return asset that is surprisingly popular with Singaporeans.
Why has the CPFIS failed in its mission? Apart from Singaporeans being highly loss-averse, I think the main reason is that the CPFIS has overestimated the ability of ordinary investors to choose what to invest. Investing on your own involves sieving through large numbers of stocks or funds. Most people simply do not have the knowledge or time to do that. Those who do invest often make the mistake of chasing trends by buying after the market has risen and selling after the market has fallen. Trend chasing is also common among unit trust investors which partly explains why in the last ten years, 80% of those who invested their OA savings in unit trusts failed to beat the OA interest rate of 2.5% (see this link).
The goal of LRIS then is to simplify investment choice. It’s main features can be summarized in one sentence: to provide CPF members with a small number of well-diversified, passively managed, low-fee, no-load funds invested on a life-cycle basis.
Since this is a mouthful, let me break it down into four components:
- Small number of funds – as opposed to hundreds of unit trusts and ILPs under the CPFIS, which only confuses ordinary investors.
- Well-diversified – most funds offered under LRIS will have a mix of global stocks and bonds to ensure that risk is spread around. Global diversification is a good thing because it safeguards against investor overconfidence which leads to concentrated bets in one or two markets. Global diversification was the focus of my previous blogs on asset allocation (see e.g., #36).
- Passively-managed – a consistent research finding is that the average active fund under-performs the market benchmark. Yet, active funds charge much higher fees than passive ETFs. Active funds may survive over a long period of time because fund houses usually offer a family of funds. In any period, some of these funds will be stars even though the excellent performance may be due to luck rather than skills. Because the average investor (you and I) don’t have the expertise to consistently pick winning funds in advance, low-cost, passively managed funds are the way to go.
- Life-cycle approach – I covered this approach in Blog #36 using the example of a two asset portfolio comprising global stocks and bonds. The idea of life-cycle investing is to allocate relatively more money to stocks when one is young and relatively more money to bonds when one is older. By doing so, more risk is taken when you have a long time horizon and less risk is taken when you have a shorter time horizon. LRIS funds adopt this sensible approach to asset allocation by automatically re-balancing and adjusting the asset mix as investors age.
Now comes a practical question: what is the chance that investing under LRIS will lead to higher wealth over the long term than leaving one’s savings with the CPF Board?
The Special Account is hard to beat given that it pays interest of between 4% and 5%. Call me conservative, but I think it’s best not to invest your SA savings under LRIS or CPFIS. I follow this principle myself and view my SA as a 4% coupon bond.
How about investing your OA savings under LRIS? The hurdle rate (2.5%) is much lower than for the SA, making it more likely that a LRIS investment can beat the OA rate. Since we talking about probabilities, I will use simulations to shed some light on the above question.
As in Blog #36, I will assume the following scenario:
- The investor is 30 years old and has a 35-year investment horizon.
- Initial investment is $12,000
- Subsequent investments occur at the end of every year, starting at $12,000 and growing by 4% annually
- All money is invested in equities and bonds
- Annual investment cost is 0.5%
- Equities is represented by a globally diversified ETF with mean return and risk of 7% and 18% respectively
- Bonds is represented by a high-quality bond ETF with mean return of 4% and 9% respectively
- Asset allocation follows a life-cycle “glide path”. The allocation to equities is:
- 80% between age 30 and 40
- 70% between 41 and 50
- 60% between 51 and 60
- 50% between 61 and 65
- Portfolio returns follow a bell-shaped curve (the normal distribution)
Here are the main results:
- If the investor leaves his OA savings with the CPF Board, he will have $1.42 million by the time he is 65.
- If he invest under LRIS, his median (most likely) terminal wealth is $1.83 million.
- There is a 70% chance his terminal wealth under LRIS will exceed $1.46 million
In plain English, the prospects under LRIS look pretty good even though I assume a relatively modest 7% average return for stocks (the historical average for the world portfolio is close to 10%). A long time horizon helps too, as does the discipline of investing regularly.
Below is a snapshot of the detailed simulation results: