Should you focus on building up your CPF before investing?

Disclaimer: Please note that all content and information in this blog are for educational and informational purposes only and should not be taken as professional investment advice.

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It is important to focus on building up your CPF first (be it through work or voluntary contribution) before diverting your focus towards growing your investment portfolio. The CPF is designed to provide for our basic retirement needs, while the purpose of an investment portfolio is to grow our savings to ultimately supplement our retirement, and for some, to leave behind assets for bequest. 

In that sense, it is possible for one to retire without an investment portfolio but it would be impossible for one to retire without the CPF. Unless one has accumulated or inherited a substantial amount of wealth, the CPF would be the primary source of income during retirement for most people, making it indispensable for many. Therefore, individuals should prioritise building up their CPF as much as possible especially during the early stages of life, given that we want to maximise the compounding effect of our CPF savings. Also, CPF provides far greater certainty and stability compared to any investment portfolio, making it perfect for retirement where certainty and stability of returns is necessary.

Hence, once you have built up sufficient funds in your CPF to meet your basic retirement needs, you can divert your attention to focus more on growing your investment portfolio to provide you another source of income during retirement beyond just the CPF.

Should you use your CPF to invest in equities?

The opportunity cost of investing CPF funds is significantly higher than using cash or SRS especially in a low interest rate environment. Nowadays it may seem more worthwhile to use invest CPF to invest since OA gives only 2.5% p.a. while cash gives ~3.6% p.a. in T-bills and as high as 4% or higher in some savings accounts. However, keep in mind that elevated interest rates are not going to be permanent. It will only be a matter of time the FED cuts rates back to pre-2022 interest rates. By then, T-bills and savings account rates would have fallen significantly as well. The current high interest rate environment should not be a reason to favour using one's CPF instead of cash to invest in equities. Like cash or SRS, CPF funds can also be used to invest in T-bills to earn additional interest beyond the 2.5% p.a. from OA.

My view

While some believe cash is superior to CPF in terms of the higher interest one can get from cash over CPF in today's high interest rate environment (thus favouring CPF over cash to invest in equities), I believe CPF is still superior to cash in a high interest rate environment, because both can give us the same return from T-bills, except that CPF has the advantage of being able to lock-in a risk-free 2.5% rate regardless of the interest rate environment — something cash is unable to offer us.

Hence, once interest rates go back down, our CPF will be far more "valuable" and superior compared to holding cash. Thus, instead of using CPF to invest in equities and hoarding cash to invest in T-bills or park in high interest savings accounts, one should invest his/her cash in equities regardless of the interest rate environment. 

In a high interest rate environment like now, we can afford to invest less of our cash in equities, but this does not mean that we do not invest at all. Consistent DCA into ETFs or high quality companies is important regardless of the risk-free interest we can earn from our cash. T-bills and high interest savings accounts are good to meet our immediate needs but not for the long term as we cannot lock-in the high interest rates for the long-term in such assets.

While SSBs allow us to lock-in high interest rates (similar to CPF) for 10 years, there is a cap of 200k which might be restrictive for some investors. Whereas CPF technically has no limit apart from the annual contribution ceiling of $37,740. Thus CPF (especially SA) is generally still superior compared to SSB.

Role of SSB in supplementing CPF

Personally, I view SSB as a supplement to CPF. Currently, at 3.33%, it makes sense to park our long term savings in SSB instead of CPF, especially if given a choice such as if we are considering whether to make voluntary CPF contributions. If so, we should consider putting our voluntary CPF contributions into SSB, as long as SSB rates remain above CPF OA rates. 

As an asset, SSB is unparalleled in the sense it is almost impossible to invest in a product yielding 3.33% p.a. risk-free for the next 10 years with the option to withdraw anytime without any penalty or principal loss. 

The only drawbacks I see of SSB is the 200k SSB limit, a lack of compounding (as interest is paid out annually) and the fact that short-term rates (e.g. 6 month T-bill) are offering higher rates now (3.6% to 3.7%). As we are in an inverted yield environment, it is unsurprising the current short-term rates are higher than the longer-term yields. Thus, there is an opportunity cost to investing in SSBs now, e.g., forgoing ~3.6% for the next 6 months in T-bills, in exchange for the current 3.3% SSB rate. While this is not significant, should interest rates remain elevated for longer than expected (e.g. hovering between 3.6% to 3.7% for the next 2-3 years), then investing in SSBs would come at a much higher opportunity cost than expected. Hence, this is an important drawback to consider before investing.

Conclusion

Regardless, I believe now is a great time to invest in SSBs, especially so as SSB rates seldom exceed 3.3% p.a. plus we always have the option of cashing out of SSB later if we need the cash, or if SSB rates climb even higher. Also, one should maximise this 200k SSB limit to supplement your CPF as long as SSB rates remain above CPF rates.

The flexibility of SSB complements the lower liquidity of CPF, while paying a higher interest rate of 3.33% compared to the OA's 2.5%.

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Disclaimer:

The content and information provided on this blog is solely for educational and informational purposes, and should not be construed as financial advice. The accuracy or completeness of the content and information provided in the blog cannot be guaranteed. Before making any investment decisions, it is important for readers to research and carry out independent verification of the information provided, or consult with a qualified financial professional. No warranty and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of actions taken based on the ideas or information found in this blog.

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