[Lessons through a story] Financial CON-sultants

TL;DR

When we accept higher risk on our funds, we should be expecting higher returns.

The Story

Received a message from a close friend one day, it went like this....

Friend: Heard you invest, can share with me more about CPF investments?

Me: CPF interest very good, near zero risk with relatively good returns of 2.5-3.5% for OA, 

Friend: Ya that is what i heard too from my agent, but she said that the CPF interest does not cover inflation, so she introduced me to low risk CPF investments that earns additional 1-2% interest compared to the CPF OA interest,

Me: Yea that sounds not bad, but got consider CPF Special accounts? It earns 4-5% per year, but cannot be used for your housing and can only withdraw after 55 if you hit the full retirement sum.

anyway what are the fees?

Friend: 3% one time admin fee, subsequent year 1%.

Me: Woah actually that's quite high, you start off with a negative base. anyway what are they investing in? Capital not guaranteed right?

Friend: ya, capital not guaranteed, and the agent got say the first few years will lose money. She said they be put into SG government & investment grade bonds, so should be quite safe bah.

Me: Do you know that global sentiments for interest rates are that they are increasing? This means that the bonds will be worth less if you happen to sell it. 

Investment grade bonds basically are debt from big corporations that are least expected to default, however if you compare with singapore government, which one more likely to default? it is more likely that the company will default compared to the government.

anyway what are your objectives for investing?

Friend: To beat inflation, and save for retirement, but also need to cater to buying house.

Me: well if that is the case, maybe you can consider transferring some money into your CPF special account, leaving enough for the downpayment of your house in the future. For your cash, consider setting aside some money for monthly investment plans (MIP) offered by banks & brokerages that allows you to enter markets with low point of entry (as low as $100)  and adopt dollar cost averaging strategy. Perhaps you should read up more on investments before you commit.

Friend: But i already committed to the financial CON-sultant. 

The Mathematics

 Just for the sake of things, I decided to do a simple calculation to illustrate.

This assumes one time lump sum input of 100K at the start, not considering subsequent investments.

For somebody in my age category (28 to 32 yr old), there is high likelihood of buying and paying for housing with CPF is within the near future of 3 to 7 years.

If you note the yellow highlights:
At Year 3, the recommended investment breaks even with the principle sum;
Within the next 20 years, the recommended investment never matches up with the CPF OA;
At year 16, the CPF SA doubles the principle.

CPF ordinary account  performance "wins" the offered investments in the illustrated scenario, if we want to utilize it for HDB down payment.

And if we look at the long term, CPF special account beats both hands down.

For the recommended investments to be more profitable than CPF SA, you will be vested in corporate bonds (for the bigger ones are 3.75ish% to 4%, while for the more junk status corporate bonds are at 6-7ish% ~think Krisenergy and stuff) this will expose you to greater risk than you would be willing to accept.

Conclusion

If we do not invest in our own financial literacy, we will always be be dependent of others to make financial decisions. Our objectives might be compromised as other people have vested interests which is in conflict with ours. In this case, the agent conveniently downplays the difference in risks for the increase in returns;  also does not highlight the likely case scenario where there is early redemption (paying for HDB).

anyway always do your due diligence in everything that has a significant impact to our lives!