Better off CPF members should welcome volatile yields
IT should come as no surprise that the interest rate for long-term funds in the CPF scheme - specifically the Special, Medical and Retirement accounts (SMRA) - will be pegged to a long bond rate.
The government had hinted at this revision in 2002 in the peg for long-term CPF funds.
Now, finally, the full picture of the new 'risk-free' framework has emerged. The 10-year Singapore government bond will be the benchmark rate. Amounts in the SMRA will earn the 10-year yield plus one percentage point. The reason the 10-year bond was chosen is that it is widely traded and easily valued. The additional premium is a proxy for the extra yield that a longer-term bond, such as a 30-year issue, might typically command over shorter-term bonds.
In addition, the first $60,000 of funds to be ring-fenced for long-term needs will earn another one percentage point. This $60,000 in funds cannot be invested under the CPF Investment Scheme.
The big question is: Are members better off? On the face of it and in most but not all circumstances, yes. The government will grant a two-year transition period where the SMRA rate will be fixed at 4 per cent.
The new framework introduces significant changes. One is volatility. Yields on the 10-year Singapore government bond, which is widely traded among banks and other institutions, fluctuate more than those on the 15 or 20-year bonds.
Based on Bloomberg data, the highest yield since the first issue in 1998 is 5.51 per cent. The lowest point was 1.79 per cent in 2003. Today the yield is 2.72 per cent. This means there will be periods when funds in the SMRA may be worse off, earning less than the current fixed rate of 4 per cent. Calculations will be done quarterly. Still, the floor of the Ordinary Account rate of 2.5 per cent will hold. That is, if the 10-year bond rate were to fall below 1.5 per cent, the SMRA rate would be fixed at the minimum Ordinary Account rate of 2.5 per cent.
Based on Bloomberg data, the average Singapore bond yield since 1998 is 3.55 per cent, which suggests members should be better off if history is a guide.
Members who are accustomed to a non-volatile safety net may feel hard done by. But given today's relatively flat yield curves there is still an implicit subsidy. At present, 30-year US Treasuries yield 4.72 per cent, about 27 basis points more than the 10-year Treasury yield of 4.45 per cent. Singapore does not have 30-year bonds, but the spread between the 10 and 20-year securities is about 50 basis points.
Fear of volatility, however, should not distract CPF members from one of the biggest challenges facing long-term savers - inflation. Will the government's premium above the bond rate be enough to at least keep pace with inflation? This challenge is particularly gruelling for the $60,000 in funds that cannot be invested. Out of these funds, members will eventually draw a stream of income.
As a simple illustration, take $60,000 in the Retirement Account. If it compounds at 5 per cent per annum over 20 years it will grow to over $159,000. If inflation was 2.5 per cent, however, the purchasing power of the end-value of that pot would be reduced by as much as 38 per cent.
Still, the decision to protect the initial $60,000 in funds from any market exposure is prudent. Those with modest assets should not subject their funds to volatility. But those with funds in excess of the $60,000 should seek diversified investments that can beat inflation. And that means embracing a measure of risk.
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