Maximising my CPF returns while I am young

The Central Provident Fund (CPF) is a comprehensive social security savings plan for retirement years. It is a tool whereby one can carry out home financing, healthcare financing and lifelong income with the end goal of a secure retirement. Those who hates it laments about it, while those knows how to work it as a weapon towards their advantage embraces it.

I was one of those who was skeptical about it, as I was not willing to go out of my comfort zone to sit down and digest the complexities of its workings. What actually intrigued me was the power of compounded interest and the taming of interest rates to your favor.

Compounded interest is easy enough to understand. It cycles “interest on interest” and if you look at it over a long term, the earlier you start the larger the snowball effect. Let us make a case in point.

Assume 2 persons A and B are aged 20 years old and retire at the same age of 55. They invest in a product which gives 5% interest per annum. A starts investing $1,000 yearly at aged 20 but stops investing at age 30. He does not take out the money till age 55. B starts investing $1,000 yearly at age 31 just at the time where A stops but all the way till age 55. What would you expect to see?

Number of years
of annual investment
Capital outlay$11,000$25,000$36,000
End result at age 55$50,515$50,113$100,628

Even though A has a lower capital outlay as compared to B, he was still able to achieve a similar return as B at age 55 because he started early. This is the power of compounding interest. What if A had been consistent with his annual investment? He would have cashed out with $100,628 with a modest $36,000 capital outlay.

Taming interest rates to your favor involves a little more appreciation about interest rates in investing and borrowing. Generally, one would prioritise investing in instruments which gives a higher return (or higher interest). For loans, prioritise the return of loans with a higher cost of borrowing (or higher interest rate). Therefore, it is also logical that when you have cash on hand but also a loan and a potential investment opportunity – to consider investing if the returns is higher than the cost of borrowing, and to settle the loan first if the cost of borrowing is higher than the returns from the potential investment.

Currently, CPF interest rate is 2.5% for the Ordinary Account (OA) , 4% for the Special Account (SA) and Medisave Account (MA). OA is more flexible in terms of usage (e.g. Home financing, education financing, investment in a wider range of instruments). The SA is geared more towards retirement needs and less flexible in usage, thus compensating with the higher interest rates. Interest is computed at the end of each month based on the lowest balance of that month and added altogether at the end of the year. Interest could be said to be compounded annually unlike your regular bank account.

I had a long consideration before I embarked on this move. Monthly housing installments is not an issue for us. Education needs would come in only at least 10 years later.

Based on what I have discovered earlier, compounded interest works wonders the earlier you start. Also, it makes more sense to invest or move to an instrument that gives a higher returns. With this in mind, I initiated the move from my OA to SA for the higher interest rate and intend to do this on a monthly basis till I reach Full Retirement Sum (FRS) for my SA at age 55.

A quick calculation shows that I will reach the prevailing FRS at that time in 5 years or less. That is assuming FRS is raised by $5,000 each year from 2019 FRS $176,000. By then, mandatory contributions will overflow to OA and we will tackle that part on how to beat the 2.5% interest rate.


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