Many Singaporeans may be unaware that besides buying a home with your Central Provident Fund (CPF) money, there are other ways to invest your CPF. This can be in the form of buying government bonds, unit trusts or even shares. However, before deciding on whether to invest in bonds, shares, or simply to let the CPF accrue base interest over time, we should be aware of all the pros and cons of each decision. In this two-part article, I take a look at the pros and cons of investing your CPF money in shares. In the first article, I…
Many Singaporeans may be unaware that besides buying a home with your Central Provident Fund (CPF) money, there are other ways to invest your CPF. This can be in the form of buying government bonds, unit trusts or even shares.
However, before deciding on whether to invest in bonds, shares, or simply to let the CPF accrue base interest over time, we should be aware of all the pros and cons of each decision.
In this two-part article, I take a look at the pros and cons of investing your CPF money in shares.
In the first article, I explained how savvy investors could benefit, while in this second article, I will look at reasons why investing your CPF money in stocks may sometimes work against you.
CPF interest rates are higher than bank interest rates
Before we invest your CPF money in stocks, it is vital that we realise the opportunity cost involved. We are essentially forfeiting a regular, risk-free 4% investment return for a riskier, but possibly higher yielding asset.
Once we decide to invest in stocks, it is also essential that we invest our retirement portfolio that we have in the bank first before touching our CPF account. This is because the banks accrue less interest than our CPF account and we should ensure that our retirement money is put to the best possible use first. That means having less in low interest yielding savings accounts and more in stocks and higher yielding accounts like CPF.
Many investors do not earn more than the 4% return from CPF
Despite the substantial gains that the Straits Times Index (SGX: ^STI) has provided over the last 20 years, the unfortunate reality is that many retail investors are still not able to beat the 4% return that the CPF Special Account provides. Even worst, over the last 10 years, less than 2% of investors were able to beat the 2% yield provided by the CPF Ordinary Account and 45% made a loss.
This may be because of investors’ tendency to invest for the short-term, having poor emotional control or misguided investment decisions.
If you are one of those investors, then leaving your money in your CPF account may be the better option.
Frictional costs may eat into returns
Another reason why some investors may not be able to reap better returns than the 4% provided by CPF Special Account is the additional frictional cost involved. When buying stocks, the investors incur a transactional cost. If investors do not plan their investments properly, this may add up, and eat into our returns.
Furthermore, investors who have a short-term approach will also incur more fees as they move their money in and out of their investments.
Risk-reward profile may not match up
CPF provides investors with a risk-free return of 4% in their Special Account. If you choose to invest your money in stocks, the rewards may be higher, but the risks incurred are also substantially greater. Some investors may end up losing their money or have to face short-term stock market volatility.
The Foolish bottom line
Using your CPF to invest in shares can be hugely rewarding for investors who adopt a long-term strategy and are able to control their emotions why investing. Having said that, there are also numerous reasons why many investors are unable to beat the CPF interest rate returns of 4%. Before making an investment decision, it is important we are aware of these risks and are familiar with our own investment acumen.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.