Buying Shares under CPFIS: 3 Things That Work Against You（z）

The CPF Investment Scheme offers CPF members a chance to beat the paltry official returns of 2.5%, but why do most people fail to beat this seemingly low benchmark?

According to the latest Q2 2012 statistics from the CPF Board, Singaporeans have more than S$4.4billion invested in stocks and equivalents under the CPF Investment Scheme - Ordinary Account (in short CPFIS-OA).

Yet, the 2011 annual statistics from the CPF Board show that only 17% of CPF Ordinary Account (CPF-OA) investors made realized net profits that exceeded the 2.5% CPF OA interest rate (a target which does not at first glance appear to be particularly difficult to meet).



While individuals’ judgments of the market are a significant factor in explaining this sub-par performance, investors are actually handicapped when using CPF funds to invest in shares. Here’s why.

(Note that for simplicity, we are assuming throughout this article that stock investments refer to those stocks listed on the Singapore Exchange or SGX)



1. Agent bank and CDP transaction charges

One of the major differences between investing your own cash versus CPF-OA funds is that in the latter, you would need the services of an agent bank to act as your go-between with the Central Depository (CDP), your stock broker and the CPF Board.

What your agent bank does on your behalf is not within the scope here, but below are the relevant charges for each CPFIS-OA transaction for shares:

S$10.70 bank charges per transaction
S$0.54 CDP charges per transaction
These are in addition to the usual commissions paid to your broker.

As an example, assuming you buy $1,000 worth of shares using cash, the total ancillary charges (including minimum commission of $25, SGX fee of 0.0475% of contract and GST), total charges would be $27.26 (i.e. 2.726% of contract value). Using CPFIS, another $11.24 in bank and CDP charges would be incurred (i.e. total effective charges of 3.85%). Of course, for larger contract values, the percentage charges of a trade under CPFIS converges towards the charges under a cash trade.

Implication: It is not cost-effective to trade in small sums and even more so if you are buying/selling shares under the CPFIS. Likewise, trading for short-term gains is punitive under the CPF-OA (in this case you are very much better-off using cash to trade).

2. CDP quarterly charges

One fact not often understood by all investors is that shares purchased under the CPFIS are not really held in their personal names. Rather, under the records of the CDP, the agent bank is the custodian (nominal owner) of the shares. For such an arrangement, CDP takes the opportunity to charge you another fee of S$2.14 per counter per quarter.



This fee is automatically billed by the CDP to your agent bank, who collects the fee from the CPF, which then deducts it from your CPF-OA.

Implication: While the quarterly charges may seem quite low, these can quickly balloon if you have a highly diversified portfolio of stocks under the CPFIS-OA. For example, a portfolio of 10 stocks would lead to $85.60 in annual CDP charges, even if you are a passive investor and have only a few thousand dollars worth of stocks. Over-diversification is definitely not recommended here.



3. Profits do not count towards stock investment limit calculations

This is one of the most understated point when CPF members are considering investments under the CPFIS.

As an example, assume you have $100,000 in your CPF Ordinary Account. 35% of this sum can be invested in stocks (but the first $20,0000 in the CPF-OA is not investible). If you buy $35,000 worth of stocks, you would have fully depleted your investible funds for stocks.

Further assume that the $35,000 of stocks you had purchased subsequently appreciated in price and you achieved $10,000 in realised profit (net of all charges).

The updated balance in your CPF-OA is thus $110,000 (if there are no other inflows into your CPF-OA during this time, e.g. from employment)

The available funds you have for your next investment in stocks is 35% of $110,000 or $38,500. It is not the original proceeds of $45,000 from your previous stock sale as you might expect! That is to say, once you realise a profit, 65% of that profit immediately becomes non-investible and your ability to compound your returns is greatly diminished (you can’t withdraw your profits either). This rule also applies to dividends received under the CPFIS.

Because of this, some investors may refrain from realising profits, which has its own downsides. For example, you may be unwisely dissuaded from (1) switching into a higher yielding stock when a good opportunity arises; or(2) taking profit even when the market cycle has obviously peaked.

Implication: The CPFIS is thus somewhat restrictive in the deployment of realized profits towards future investments. It is also not conducive for savvy investors who take an active interest in portfolio management.



Conclusion

Stock investing under the CPFIS can be a profitable exercise, though the odds are actually stacked slightly against your favour when compared to investing using cash.

Generally, stock investments under CPFIS would be favourable only if the value of each contract is not too small, with a portfolio limited to not more than (say) 5 stocks. Moreover, to beat the odds, you should preferably not be intending to actively tweak your fund allocations between stocks in your CPFIS portfolio.