Thursday, August 4, 2016

New CPF Changes

I gotta admit, I only found out about this yesterday after reading Uncle CW8888's blog post about it. I went to search google and I found these articles by the MSM (CNA and ST), but I couldn't find any more in-depth details anywhere else.

Then I woke up today and I saw Kyith's post on it, which is just awesome! It is very detailed and I think it is the best resource about this new CPF Life scheme out there (so far)! He also talks about the LRIS. I think he gave very good and reasonable insights about both of these things.

Since Kyith has already done such a good job, I'm not going to talk about the mechanics and the specifics of it. If you want to know more, just head out and get overwhelmed by the amount of info that he provided! I'll just give my thoughts.

CPF Life Escalating Plan

Personally, I think that this is a very good development to include this escalating option. The thing only improvement that I can think of? Is to have an option with low bequest. Many naysayers of the CPF Life scheme have continually complained about the level payouts and the lack of any inflation-pegged or escalating payouts. Well, now they finally got what they've asked for, but somehow I don't know if this would really turn the tide for most people.

Basically, when it comes for people deciding on which CPF Life plan to make, they should only have to make 2 decisions:

1. Low/No or High bequest for their beneficiaries
2. Level or Escalating payments

For people who have no beneficiaries (FYI, you don't need to be single to have no beneficiaries. You can also be single and have beneficiaries, like a charity), choosing the option for a larger bequest makes no sense at all. What need do you have of the money after you have passed away? In that case, you would choose the option with the lower bequest, and hence, a higher payout rate.

Next, people should decide if they want level or escalating payments. The benefit of level payments is of course simplicity, and predictability. I say simplicity as a benefit, although in many cases in finance, it can be a bad thing. Simplicity is good because it helps people fully understand the choice that they are making and allows them be at peace with the outcome - whether it is favourable or not. Choosing an option that you have absolute certainty over is quite comforting for most people, especially if the alternative is something that is complex and beyond your understanding.

Of course, simplicity does not make a product better. It just makes it easier for the purchaser to understand. Predictable payments can be a good thing too, especially if much of the expenses are fixed and perhaps frozen from increasing. The higher initial payment of the level plan may also work out better for some people if they do not predict that they will live very long. Perhaps they have certain medical problems. That said, if you think you are going to live long and prosperous, the answer is obvious - take the escalating payments.

For people with no beneficiaries (relatives, charities, etc), the answer is simple. Choose the option with no bequest.

For people with beneficiaries, the choice becomes slightly more complicated. Level or escalating? I believe the deciding factors are made up of matching expenses to payouts, and also personal expectations of longevity.

Lifetime Retirement Investment Scheme

For the LRIS scheme, I also do think that it is a positive development, although the take up rate may not be a good as what the G hope for. In fact, I think they ought to scrape the CPF-IS (OA/SA) or at least plan to phase it out so that current investors have ample time to exit and switch over.

Having low-cost, stream-lined choice of funds is a good thing in my opinion. Firstly, the costs of many funds are just too damn high. Secondly, I think many investors get decision paralysis when they look at the huge number of funds that they can choose to invest in! It isn't a wonder why many people end up choosing very strange funds and end up with poor performance.

However, like what Kyith points out, although the returns are higher, taking into the account the high risk-free rate of the CPF SA account, it would be leaping from almost fortress-like safety into the wild volatility of the world's markets just to make a few extra percentage points. It just might not be enticing enough to get people on board this LRIS scheme.

Personally, I have 2 suggestions for the LRIS which I think could improve it.

Firstly, have a lock-in period for LRIS, and possibly reward the lock-in commitment. The rewards of the lock-in period could be a variety of things. For example, maybe waive off fund fees for the lock-in period? Or perhaps a 10 year lock-in period (means unable to sell the LRIS fund units back to the CPF account) can give guaranteed capital return of... 10%? Essentially, the G would be taking a bet that the fund would be able to generate at least about 1% a year, and if not, they would be willing to top up the shortfall. If the funds that they decide to include can't even make 10% after a period of 10 years, then they really have a problem in selecting funds. Honestly, it might seem unfair to regular retail investors like you and me who have to take the full blow of the markets and sometimes swallow losses, but if the G really believes in long-term, passively managed and low-cost investing and wants to push people in that direction with their risk-free CPF monies, I think they need to offer a bit of an incentive, instead of only trimming down fund expense rates. No downside, only upside. Something like the SSB, but for CPF monies and for equities.

Secondly, it would be to allow SRS funds the same access to these LRIS funds. I like to think of SRS investors as a very similar investor of those with CPF IS-OA/SA. The money is locked away for a long time, but for the benefit of possibly withdrawing at a penalty, there is zero guaranteed returns. In fact, the SRS investor would be very hyped if they were able to also invest into the LRIS funds! LRIS is in line with the SRS since they are geared towards long-term retirement investing, so there is a very good match investment objectives and investment timeframe. Also, the zero risk-free returns means that the returns of the LRIS funds would be very well received. It is definitely a more natural progression to move such money into funds compared to moving CPF monies that are earning a good risk-free rate into funds. By letting SRS investors in, LRIS funds would also get more capital and hopefully that means that they can be run more efficiently and cheaper!

Personally, as derange and crazy about risk-taking as I am (my investments in Gold miners and Russia would like to say hello!), I am not tempted to use my CPF monies and invest in the LRIS. To me, I feel that the risk-free amount in the SA is disgustingly high and I prefer to view my CPF as the bond portion of my portfolio - the portion where I am risk-adverse. For my risk-seeking thrills and investments, I would be using my cash or SRS money for it. Really, the main key difference is the risk-free rate the different cash is able to get. Why give up 4% interest to make 6%? It is much better in my opinion to leave that 4% as is, and use the money getting 0.05% (local bank savings deposit rate) and aim for 6% instead.

However, for people with long time frames and are unable to invest outside of CPF (no savings, cash flow), it is possible to outperform, but it does come with risks. I think that the risks are misplaced,

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In all honesty, I think that CPF is one of the best things about being Singaporean. I know a lot of people who would disagree with me, hate it and think it's a giant scam, but whatever floats their boat. Many of the older generation who have faithfully contributed to their CPF and are in retirement are happy with their outcome, while those who try to contribute as little as possible are feeling like they don't have enough to get by. Perhaps it is merely a coincidence. But it is probably not.

Sometimes I wonder if people really understand what the CPF is for. It's for personal retirement. It is not a government tax to eat into your salary. It's forced savings, because frankly, too many people are too incapable of saving for their own future.

3 comments:

  1. I happened to have read K's article before yours. Being a newbie on such topic, i always thought that CPF is to give back whatever amount of money i have put in earlier, with the guaranteed 2.5%/4% interest compounded, but no more no less. Am i wrong that CPF OA/SA, or these two new schemes will actually provide me more than that? It will be a good relief to here my old age is covered by CPF enhancement.

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    Replies
    1. Hi Bruce,

      I think for most people, CPF is mainly used as a 2.5% / 4% (+1% bonus) retirement savings account with the money that you put in.

      With the new LRIS scheme (and also the existing CPF-IS OA/SA schemes), it is possible to generate returns higher than the minimum CPF guaranteed rate, but those returns are not guaranteed and any losses will be borne by the investor. The LRIS just increases the odds of long-term success by reducing expenses drag and narrow fund choices.

      CPF members have a choice between 2 extremes:
      1. Not taking part in any of the investment schemes and just receiving the 2.5% / 4% guaranteed rates (or whatever rates in the future, as determined by the benchmark)
      2. Risking their CPF monies by investing it into one of the various schemes. They have the possibly to earn more, but are not only at the risk of not only earning less than the guaranteed rates, they are also at the risk of making losses!

      I say that this is a choice between 2 extremes because you don't have to choose only 1 or the other. A CPF member could decide to put all their available investible monies into the investment schemes for the next 20+ years, and then perhaps slowly cash out their units when the market is doing well and slowly convert it back to the "bond" portion of their CPF. The closer you are to retirement, the less you would want to put your assets at risk, since certainty of a final outcome is usually more favoured than high volatility to squeeze out some excess returns.

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  2. Hi GMGH,

    Thanks for the perspective. I really like your suggestions for LRIS, and you are right, there needs to be an incentive. People need some smart nudges.

    This is very like Australia's system. You either force people on it, or give very strong inicentive or remove the 2.5% and 4% for the traditional one.

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