Most people after they graduate from University and start working, their goal would be to pay down their student debt, and save up for housing, car, marriage, etc.
That’s not a wrong idea to have, paying your debts down and all, especially if you took a bank loan that charges about 5% per year in interest.
I took the CPF loan out from my mother’s account, and the interest is 2.5%, and honestly, I am not that much in favour of paying back them soon. Here’s why:
- It’s a low-interest loan
Okay, it’s not exactly that low but it’s not that bad. It is comparable to say a housing loan. So it’s better that I extend this low-interest loan and use the excess cash to invest in assets that give higher long-term returns (like stocks). - It is a form of interest arbitrage
Refer to one of our latest articles to understand why - How the Rich Play the Money Game
- It can’t be used for expenses, even wedding, proposal, home renovation, etc.
- It can’t be used for anything that won't give you an investment return.
- It can’t be invested in assets that give you low returns like bonds
- Your parents have to be ok with you dragging the repayment (ie; they not in a rush to have money in their CPF). Sometimes they might need the money inside for housing, some times for your siblings’ future study.
- Your parents have more than $60k in CPF. This is a bit more complex. So because the first $60k in CPF gets +1% interest, and those age above 55 gets another +1% on their first $30k. Essentially that is like a nice 4.5% interest per year, which is a pretty good return that can be quite hard for other asset classes or investments to beat. In which case, it’s better to return the money early to earn the 4.5% guaranteed by CPF than to try your luck in the assets market
Recommended Read: CPF Life or Private Annuity Plan?
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Don't know about now, but when I graduated in the early-1990s, CPF sent me & my classmates a letter with various re-payment schedules. The weird thing was that the quantum of excess above the principal (i.e. the interest) was the lowest for repayment over 5 years. Yeah it was more if you repaid early, say in 3 years! So we all chose 5 years back then.
ReplyDeleteNow that I think about it, I suspect it had to do with the changes in CPF interest rates during those years. Many fluctuations in the 1980s and 1990s!
My opinion from a parent's perspective. (For both my two children's local university (NUS & NTU) education, we took bank loans which were interest free during the four year course that each of them undertook. They graduated 5 years apart from each other. Upon their graduation, and the moment the bank started to levy interest on the loan, we immediately paid off the loans without incurring any interest cost.)
ReplyDeleteFor those children that utilized their parents' CPF monies to fund their university education, I would advise them to quickly return the money into their parents' CPF rather than attempting to invest them. The reasons being:
1. The amount attracts 2.5% pa of interest from the very moment it was withdrawn from the OA. And this interest is compounded each year.
2. As a young graduate, you may not yet acquire the necessary skill nor knowledge to invest. So why not let the CPF pay your parents the 2.5% interest risk free rather than you as the young graduates take this risk? Not only that you may not beat the 2.5% interest, you risk losing a portion if not all the principal amount.
3. As a young graduate worker, you may not have substantial savings to invest. Buying small amount of shares is not cost effective. The commissions you pay the brokers will make up a relatively high percentage of your cost.
I would advise young graduates to save up first and not rush into investing. Pay back your parents' CPF as quickly as possible and invest only when you have substantial savings. And do not invest all your savings, but remember to keep a portion as emergency fund, another portion as opportunity fund and a pocket money fund.
It will take some time of savings to build up the various funds. Wealth building is a journey, it will take patience, discipline, consistency and persistence!
Hi,
DeleteIt would be nice to have parents to help pay for education - although that kind of defeat the purpose of finance self-reliance and I don't think everyone is lucky to have a parent like you :D
Nonetheless I do agree that for most, it would be ideal that they repay their parents CPF asap since they would not have the skill or knowledge required to do well in the stock markets. But, if they do have those skills/knowledge, then it would be wise that they drag out the payment period - assuming their parents are fine with it and their parents have preferably >$60,000 in their CPF accounts.
Hii nice reading your blog
ReplyDelete