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Investor psychology and beating our fears.

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"E-book" by AK

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CPF or SGS?

Monday, April 1, 2013

When I revealed that I did a voluntary contribution to my CPF account earlier today, someone told me he is scared of the CPF and would only contribute what is required by law.

I said that the CPF gives us relatively attractive, risk free returns. He then asked why not consider the 30 years SGS (Singapore Government Securities) with a 2.6% return and have some upside to boot.

Well, the SGS are quite different from the CPF, aren't they?


When we do a voluntary contribution to our CPF account, the contribution is apportioned to the OA, SA and MA. The OA pays 2.5% while the SA and MA pay 4.0%.

CPF money is actually long term savings, a very long term fixed deposit of sorts. The principal sum does not change. We can't actually lose money, so to speak.

When we buy long term SGS, we are buying bonds. We might get 2.6% per annum with the possibility of some upside but the possibility of downside exists as well.

Actually, a quick check over at MAS' website will show that the 30 years SGS which is supposed to pay a 2.75% coupon has fallen in price. See: Daily SGS prices.

As I believe that the very low interest rates we currently see cannot persist for many more years, buying long term bonds is a risky proposition. Why?

For bond prices to rise, interest rates have to continue falling. How likely is this? It is more likely for bond prices to fall in the coming years as interest rates once again start to rise. It is not a matter of "if it happens" but "when it happens".

I have money stored in four war chests. My CPF-OA and CPF-SA are two.

Money in these accounts earn relatively attractive, risk free returns while waiting for possibly more compelling propositions to be offered by Mr. Market.

Money in bonds is like money in equities in that they are not money in a war chest waiting to be deployed. Or am I mistaken?

Related posts:
1. Be cautious even as we accept higher risks.
2. Build a bigger retirement fund with CPF-SA.
3. If we want peace, be prepared for war.

23 comments:

Kim said...

Hi AK
If your SA already reached the limit, can you still do a VC?
And does the VC enjoys tax relief as SRS contribution?

Cory said...

Logical and well said.

AK71 said...

Hi Kim,

Not too long ago, I had a very good exchange with Serendib and Bill on the subject. You want to see the comments section of the following blog post:

Make more money, do good and pay less income tax.

To answer your questions:

1. Yes, you can still do a VC if your SA has hit the minimum sum limit.

2. No, VC does not enjoy income tax relief.

AK71 said...

Hi Cory,

Thank you. :)

Money should go to where it is treated best but the definition of "best" could differ from person to person.

There are so many sets of assumptions we can adopt, after all. ;)

Ray said...

but AK. at the rate the age limit is being increased, you may never get to see your "additional savings" until you are 70 years old.

Singapore Man of Leisure said...

AK,

We are living in interesting times.

US 10 year treasury is yielding 1.84% while US equity markets near all time high.

Both markets can't be right; but here we are!

All of sudden, CPF 2.5% not so bad afterall ;)

AK71 said...

Hi Ray,

I hope I will not have to draw on my CPF savings in my old age and if I should do so, it would only be because all else failed.

I am more concerned about growing and preserving my wealth in what should be a meaningful way now. The CPF is a useful tool in my efforts. :)

AK71 said...

Hi SMOL,

Indeed so. Interesting times.

A reversion to the mean is what any reasonable person would expect but Mr. Market is hardly reasonable. So, what are we to do?

Think the 8 Immortals. ;p

Ray said...

Well, if we are talking about preserving capital, then CPF interest is still below inflation rate right?

AK71 said...

Hi Ray,

The CPF is a useful tool in my efforts to grow and preserve my wealth but not directly so. If I think of the CPF as the ultimate tool in wealth preservation, I must be bonkers.

We must have cash on standby at all times. Without ready cash, we could miss out on possibly fantastic wealth building opportunities. Where do we keep our standby cash?

A regular savings account pays 0.1% per annum. Savings account for privilege banking customers pays 0.3% per annum. Money I leave with my broker pays 0.5% per annum. SRS pays 0.1% per annum. All these pale in comparison to CPF-OA and SA.

Of course, they are not the same and have their advantages and disadvantages but to function as war chests, they are all adequate tools. :)

Happy Pork Belly said...

Hi AK,

I don't know what is SGS, but I agree with you on the correlation between bonds and interest rates.

But for CPF, I will not put my money in there where possible. I had recent dealings with CPF to help elder members of my family. It just proves a point that it is a coin box which has no key and cannot be broken.

Shhh...I don't want to turn your blog into a different topic, but you get me. Different people encounter different things, and I am glad about my encounter.

Kent Ng said...

AK,

You are right to build up OA war chests. When Mr market decided to turn and everyone rush for the exit, your OA $$ could potentialy gains in multiples of 4%.

Should the draw down age increase beyoung 70, you still have 3rd and 4th war chests to tide thru...

Best Rgds ....... Kent

AK71 said...

Hi HPB,

SGS stands for Singapore Government Securities. The longer term ones are bonds. :)

My parents are beyond retirement age but they are still working. They have rather good experience with the CPF and, in fact, did VCs last year too.

OK, I think I just saved my blog from being gazetted. ;p

AK71 said...

Hi Kent,

While I wait for investment opportunities to present themselves, I like the idea that money in these war chests are enjoying way better returns than what is offered by the banks on S$ savings.

Of course, the fact that this works for me does not mean that it would work for everyone else.

lzyData said...

I suppose your friend is worried that the government will feel free to change the laws around CPF so that he cannot get his money when he expects to and all of it, but the government will not feel free to default on SGS interest and principal because that will have repercussions for our credit rating.

In theory that would make sense because the latter has not happened but the former has. But your friend is ignoring the far more obvious factor of interest rate risk. As you point out, yields are historically low both globally and for SGS. Either your friend eats a loss on his long-term SGS in future, or he will get stuck for 30 years till maturity, for 2.6%.

AK71 said...

Hi IzyData,

The Singapore government has AAA credit rating. There is no risk of default, of course. However, the risk of losing money in the bond market is very real in the coming years.

As for the CPF, there is no risk of losing money, so to speak, even as it pays almost the same "coupon" as a long term SGS.

Also, I do not see why it is such a bad thing to have some money "stuck" in the CPF. A big portion of the money is contributed by our employer(s) and also from the relatively attractive interest payments accumulated over the years.

If we did not have the CPF, how much would we actually have even if we were to religiously contribute 16% of our monthly wages into a forced savings program? Not half as much, surely.

I think people forget the bigger mission of the CPF sometimes and the greater good that it does. It helps us build up a nest egg.

I would probably opt for the CPF Life program that pays me less allowance a month when the time comes and leave the rest to my family the day I leave this world. I don't think that is such a bad outcome, do you? :)

lzyData said...

What you say is right. I am a big fan of the CPF system too. The alternative where you let everyone save whatever they want and invest however they want with no government intervention (providing the safe long-term assets) will be a disaster for most, although it will be very lucrative for the financial industry. In the US, there are trillions invested in 401(k)s and IRAs and the industry collectively skims off at least $100 billion a year. People advocate privatising Social Security because they salivate at that even bigger pot of money.

But then, there is a common mentality that the government is holding me back by keeping my money in CPF, or worse, that the government is doing this because it has no money to pay me back. (As if your CPF money is sitting in a big vault somewhere for 30 or 40 years.) Ironically people can believe the government is rich and also believe the government has no money to pay back their CPF. As for saving and investing their own money, maybe everyone thinks they could be Warren Buffett IF ONLY they had the freedom to be, but I don't think Buffett was held back because he had to pay Social Security taxes.

Your friend's viewpoint is unusual and interesting in that he seems to understand that SGS is a safe asset but he does not think CPF is, although they come from the same issuer. That's more nuanced than the usual conspiracy theories you hear :P

I believe CPF LIFE is now compulsory so you will not have to opt for it, haha. According to the 2011 life tables (Singstat), a 55-year-old can expect to live another 28.8 years, a 65-yo 20.2 years. That means around half the cohort will live beyond 85-yo, which is the point where the old Minimum Sum Scheme runs out of money and you're on your own. Half!

We need a plain vanilla life annuity to protect the long-living and the government through CPF is best placed to provide one. But of course there are people who don't understand the purpose of annuities or just don't like being forced to do anything, even if it is for their own good.

AK71 said...

Hi IzyData,

Thanks for taking the time to make such a well thought out comment. I truly appreciate it and I am sure some other readers do too. :)

People will believe what they want to believe. It is just like how some people who do not have to pay a single cent of income tax because they qualify for a host of reliefs still feel that they have been wronged by the government.

There is just no talking to some people, I have discovered. So, these days, I try not to bother.

We do what we feel is right for us and that's that. ;)

AK71 said...

Singapore bonds slumped, pushing 10-year yields to a 22-month high, after better-than-forecast U.S. jobs growth kept alive speculation the Federal Reserve will cut back on monetary stimulus.

Source:
http://www.bloomberg.com/news/2013-06-10/singapore-bonds-decline-as-10-year-yields-climb-to-22-month-high.html

AK71 said...

"You shouldn’t be 40% in bonds…. Anybody I would [advise], I would have them having enough cash on hand so they would feel comfortable, and then the rest in equities…. I would have productive assets, I would favor those enormously over fixed-dollar investments….

Stocks are reasonably priced. They were very cheap a few years ago. They’re reasonably priced now. But stocks grow in value over time because they retain earnings and they expand the companies underneath. I like owning stocks now, I do not like owning bonds now."


-Warren Buffett

AK71 said...

Singaporeans will continue to enjoy an interest rate of 4 per cent on their Central Provident Fund (CPF) Special and Medisave Accounts from Jan 1 to March 31, and on their Retirement Account from Jan 1 to Dec 31, the CPF board announced on Friday.

Savings in the Special and Medisave accounts currently earn either 4 per cent or the 12-month average yield of 10-year Singapore Government Securities plus 1 per cent, whichever is higher.

Additionally, an extra 1 per cent interest will continue to be paid on the first $60,000 of a member's combined balances, with up to $20,000 from the Ordinary Account.

From Jan 1, the Medisave Required Amount will be adjusted to $40,500 from the current $38,500 and converge with the current Medisave Minimum Sum.


http://www.straitstimes.com/breaking-news/singapore/story/4-interest-cpf-special-and-medisave-accounts-and-retirement-account-20

AK71 said...

Vasu Menon, vice president of Wealth Management Singapore at OCBC Bank, said: "Investors are sitting on cash and will be seeking higher returns because interest rates will stay low even though the Fed tapers in 2014.


“The search for higher yields, higher returns, will result in investors searching, going towards equity markets which have produced and can produce pretty good returns for investors. But given concerns of tapering, we are cautious on bond markets."

Singapore equities are preferred within Southeast Asia, as local corporate earnings momentum is expected to improve.


http://www.channelnewsasia.com/news/business/singapore/positive-outlook-for/921836.html

AK71 said...

Wong Sui Jau, general manager of Fundsupermart.com (Singapore), said: “The hunt for yield actually hasn't reduced, not until interest rates rise to a level where even fixed deposit rates or rates from savings accounts are decent.

“But I don't think we're anywhere near that yet, so there'll always be the hunt for better yield. Bonds and bond funds are able to provide this without the kind of risk and volatility you have to take on by going into equity markets."

Source:
http://www.channelnewsasia.com/news/business/singapore/subdued-outlook-for/1245730.html

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