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When the Government Intervenes Too Much….

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DSC_1743[1]I saw a HDB infographic at the MRT station at Boon Keng today and thought about whether the change in policy was thought through thoroughly enough by the policy makers.

I refer to the change in rules governing purchases of HDB flats from maximum 30 years to 25 years loan tenure.

On one hand the government seemed to have taken some of the messages of the last election in 2011 to heart and communicate its policies more, witness the infographics, the ads of the pioneer generation package in the form of TV advertisement using soccer analogy instead of its usual mailer with cartoons.

However, when policies are rammed through without consultation, feedback and proper studies, their overall effect is to make the ordinary Singaporean less well off.

If you refer to the two scenarios below, you will understand why:

 

Scenario A  
housing loan int 2.60%
index funds 5%
term 25
no. of mths 300
loan amount 420,000
   
   
housing loan payment each month -1,905.41
Investment term no. of months

60

Investment from 25-30 years 129,579.60

Scenario B  
housing loan int 2.60%
index funds 5%
term 30
no. of mths 360
loan amount 420,000
   
   
housing loan payment each month -1,681.43
Use difference for investment -223.99
Investment from 1 to 30 years 186,413.57

 

Scenario A is the one the government has changed to, where the tenure of loans cannot exceed 25 years. The rationale is to force people to buy flats within their means and then use the money that they will have saved from year 25 to 30 years into their retirement.

If we assume that,

1. The people taking the loan are rational and does what the government wants and will not use it for other purposes like fund their children’s education etc instead of funding their retirement.

2. The rate of return for investment is conservatively estimated at 5% with the assumption that the people will chose an index fund or exchange traded fund like the STI ETF which has yielded above 9% as at 16 Jul 2014.

In Scenario A, the family who finished their loan at year 25 and immediately invested the same housing loan amount to an index fund yielding 5% will have gotten about $129,579.

Which is not too bad.

What about Scenario B?

The folks who was under the old policy of a housing loan tenure of 30 years will have fared better by getting $56,833 more, if they had invested the difference of $223.99 each month to the same index fund earning 5% per annum.

The folks who was under the old policy will have fare better. Anyone who studies economics or finance will understand the effect of compounding interest.

So when the government forces the loan tenure to be shorter, it is in effect reducing the incomes of couples starting their families and reducing their ability to invest and finance their own retirements at the very start, when it matters THE MOST as early compounding means that the money pile at the end is much bigger,

 

Source:

1. http://www.spdrs.com.sg/etf/fund/fund_detail_STTF.html as at 16 Jul 2014 at 9.05%


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Putting ‘Rocket Boosters’ to CPF

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There has been a lot of consternation and anger about the CPF scheme and the minimum sum recently.

While the CPF scheme in general works well, it is perhaps a little too conservative and benefits the government of the day rather than the general public in terms of the benefits gained from investments using the CPF monies.

This does allow the government the benefit of spending this money as it sees fit and helps fund infrastructure developments, social programmes, education and others.

I will argue that it is better to put it into the hands of the general public. At least a portion of it. A bit of a half-measure.

I propose a rather drastic amendment to the CPF scheme.


Let me explain further.


1. For the first few years of one’s working life, the entire CPF contribution of 36% should go to one account, let us call it OA-R (as it Ordinary Account- Retirement/Rocket Booster or OAR for short). And this account earns 3.5% (the present rate of 2.5% with 1% for amounts up till $60,000 in either OA or SA currently)

2. After this account reaches $21,000 (which should be about 4 years if you earn $1,100 or 3 years if you earn $1,500), this amount is transferred to an account that invests in an index fund like STI (or a mix of STI and S&P 500 or a mix of some other index funds/ETFs). The benefits of index funds/ETFs are the low cost and annual fees, which means that this $21,000 works harder for you in what Albert Einstein termed as the 8th Wonder of the World- the magic of compounding.

3. Assuming this person who reached this $21,000 milestone is now 28 years old (earning $1500 a month), and this entire amount of $21,000 is kept in the index fund with dividends reinvested, when he or she reaches 65 years old, this is what this $21,000 will look like under the different investment return rates:

Rate of Return Amt @ 65 years old
3.50%
$74,576.93
4.50%
$107,834.97
5.50%
$155,876.93
6.50%
$225,253.40
7.50%
$325,408.14
8.50%
$469,951.68
9.50%
$678,493.95

4. As the STI returned about 8.5% for the past 10 years while a literature search of any good financial books will tell you, the returns from stock investment in the whole of the stock market can be pretty decent, so a range of 6.5% to 7.5% is doable. After all, didn’t Temasek Holdings and GIC claimed to have investment returns in excess of 10% over many years? The interesting thing here is that anything above a 5.5% return will have met the minimum sum. And that is with just the first $21,000. After investing this $21,000, the CPF reverts to the current model. For the purpose of comparison, the current 3.5% and 4.5% is illustrated here to show the returns possible even with current rates earned through CPF.

5. So assuming that we take the amount when you reached 65 years of age and invest the amount in an annuity. And now this annuity has more bonds, let’s say 80% government bonds and 20% equities(ie index funds) for a conservative return of 3.5% for each of the rows in the table in point 3 for 20 years till the age of 85. What will be the monthly amount a retiree will get?

Rate of Return Mthly Payout
3.5%
$432.52
4.5%
$625.40
5.5%
$904.02
6.5%
$1,306.38
7.5%
$1,887.24
8.5%
$2,725.53
9.5%
$3,934.99

Now that monthly payment doesn’t look too shabby right? And this is just with $21,000 invested when you are 28 years old.

6. So after the age of 28 years old, the CPF reverts to its original form with different amounts going to OA, SA and Medisave for the respective needs.

7. There could be people arguing that one will need medical insurance in case something should happen between the years when you are 25 to 28 years old.
i. There could be an alternative where the current 29% goes to this OAR account and 7% to the Medisave while the young person saves a while more to hit the $21,000.
ii. There could be also be people arguing that the first initial $21,000 should immediately go into this index fund and roll away the compounding interest earlier.
iii. Also, for illustration, I have kept the transition from investment in index fund to annuity to be a direct one, however, in real life, an annuity like the current one transits from 55 years of age to payout when you reach 65 years of age. However, if the annuity is managed through the government and invested in government bonds, this can be made a seamless transfer of monies between different entities that are linked.
iv. The other downside could be that young people will be wary of buying their first home and delay their marriage. This can be reduced with the existing government grant for buying HDB flats being expanded further or for a scheme whereby CPF loans the initial house loan deposit ( the first 10% or 20%) on top of the HDB or bank loan. After which the person pays back both the intial loan and the HDB/bank loan. 
8. The government still get to benefit from the CPF amounts invested after a person hits the $21k mark with funding still available for excess returns after paying off the government securities used to pay off the CPF interest rates for the public.

9. People still get to pay houses using their CPF OA account after they have prepared for their retirement using the first $21,000. And their risks are hedged as they will still accumulate SA amount after they are 28 years old which will be additional money for their retirement.

10. This may even allow more flexibility to how SA account can be used, for example, appeals through their Members of Parliament for partial amounts in the SA account to be used in the cases of long term unemployment, sickness in family etc as OAR is already being set aside for retirement.

11. The government still have money from investment returns from reserves to fund all the programmes that they feel is needed. In fact, by keeping 80% of the annuities in government bonds, the money there could replace that of the $21,000 OAR invested in index funds.

12. And more importantly, the people don’t have to worry about ever fulfilling the ‘minimum’ sum or retirement, while their retirement is more assured as the risks of managing the retirement is spread between the private index funds and public linked bodies which manage the reserves in the government, namely the MAS,GIC and Temasek Holdings.

13. Thus, we can consign the word “minimum sum” to history.


What do you think?


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Why Don't We Get 8.4% on Our CPF?

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Read this article from Motley Fool about the Straits Times Index EFTs getting an annualised 8.4% over the past 10 years.

While our CPF ordinary account is getting a miserly 2.5% that is getting beat by inflation.

Although we can invest amounts above $20,000 in the CPF ordinary account into approved stocks and unit trust, this rule puts a damper on everyone's CPF accounts, especially those who are starting to work, or those whose pay is low and those who are not investment inclined.

More important is the fact that just the average dividends given by the STI ETF alone will have beat the 2.5% given by the CPF.

The reply by our government that the interest rate is low because our currency is strong is pure hogwash. If you are using the CPF funds to invest all over the world and boasting that you are getting investment returns that is on par or beat that of Warren Buffett's Berkshire Hathaway, that explanation is laughable.

So why not just put all the CPF funds into STI ETFs, get dividends higher than 2.5%, have a more than even chance of getting capital returns with dividend as high as the 8.4% achieve over the last 10 years?

At one stroke, everyone with CPF account is better off, you don't need to hire all those money managers to try to beat the market, avoid fiascos like buying Citibank, Merrill Lynch and dumping their stocks at a huge multi-billion losses.

This is one example of the nanny state trying to be too clever.


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