Investment Moats

If you have a sum of money in your CPF Ordinary Account (OA), is it better to pay a greater down-payment or to take a larger loan and delay repaying your CPF Ordinary Account?

A reader of mine asked me this question and my answer to him is that based on my past research (you can read Should we repay more of our 2.6% HDB loan to save 0.1%?) it should be better to drag out the loan.

I think the general idea is that if you have more lump-sum in your CPF OA as early as possible, it allows your CPF OA to compound over time. But there are a lot of things I cannot explain why this is the case.

The question today is more clear cut because instead of choosing to consistently repay $XXX a month more towards your mortgage, we are deciding whether or not to contribute more money to downpayment or not to.

I can tell you the answer is that it is mathematically better to take a larger mortgage loan versus making a greater downpayment.

Now, let us look at why this is so.

The Opportunity Costs of Using or Not Using More of Your CPF OA to Pay for Your Home.

This the problem brought in front of me:

1. You can take a $400,000 home loan at 1.3% a year in interest rate, and have $200,000 in your CPF OA earning 2.5% a year currently
2. You can reduce your home loan to $200,000 but you would have zero in your CPF OA

The pivot amount would be the $200,000 that you have in your CPF OA. In the past, CPF would force you to use all your OA to downpay for the home. What I understand is that this is no longer the case.

The way for you to think about is: What is the max loan that you could take?

Then, how much is in my CPF OA and how much do I want to keep in my OA.

If you choose to take a larger mortgage:

1. You would pay more interest over 25/30 years. In theory, the interest that you pay is not fixed. At the start of your loan, you will pay more interest (due to the size of your loan). As your loan becomes smaller the interest is reduced.
2. You would have money in your CPF OA to compound at 2.5% a year.

If you look at this math, intuitive this is a no-contest. We should do this since you would earn in excess of 1.2% if we take 2.5% minus 1.3%.

If you make a larger downpayment:

1. You pay less interest over 25/30 years
2. You will missed out on the 2.5% a year compounding in your CPF OA

So there is a 2.5% a year opportunity cost and your “return” is saving money on the 1.3% a year interest payment.

Net-net you will lose out on 1.2%.

We should always choose taking a large mortgage loan in this case. However, what if interest rate is closer to 2.5%?

What if you are taking a 2.6% a year mortgage loan? Let us see whether we can explore this.

Before we move on, do take note that the decision point is on the amount in your CPF OA that you need to make decision on, not the entire home loan.

Comparing the “Returns” Profile Between the Two Mortgage Financial Decisions

What we can do is to compare the internal rate of return for the two decisions.

Whoever has the higher internal rate of return is mathematically the better decision.

The internal rate of return (XIRR) needs to be computed between two streams of cash flow.

The XIRR, in very layman speak, is the “compounded interest rate per year” that you can earn based on this decision that you take. If we have an XIRR of 2%, you can interpret that this irregular stream of cash inflows and outflows will generate 2% a year compounded.

With this XIRR you can compare to other investments. For example, compare this to putting your money in an endowment plan earning an XIRR of 2.5%.

In this case we can compare the XIRR between both our decisions.

The first stream of cash flow is to not pay more downpayment but to take a larger mortgage. The cash flow would look like this:

1. Year 1: Putting $200,000 in CPF OA – Outflow
2. Year 2: Interest expense – Outflow
3. Year 3: Interest expense – Outflow
4. Last Year:
   • Get back your $200k principal from CPF OA – Inflow
   • Interest expense – Outflow
   • Accumulated interest earned from CPF OA over the years from the $200k in OA – Inflow

The second stream of cash flow is to contirbute more to downpayment and have less in your CPF OA:

1. Year 1: Paying away $200,000 more to downpayment – Outflow
2. Year 2: Interest expense that you saved by down-paying more – Inflow
3. Year 3: Interest expense that you saved by down-paying more – Inflow
4. Last Year:
   • Accumulating $200k in home equity after completely paying off the home – Inflow
   • Interest expense that you saved by down-paying more – Inflow
   • The opportunity cost of the accumulated interest we could earn from CPF OA over the years from the $200k in OA – Outflow

I decided to plot these two internal rates of return (XIRR) on a chart. The idea is to see how the returns change as time passes.

The return graph shows that the return profile of not paying off early is positive while making a greater downpayment is negative.

This more or less is inline with our guess.

Note: to be fair if you down pay more, at each point on the chart, you cannot get back the $200,000 principal (which I am assuming). The reality is that you would build up the equity of your home over time and only in the 300th month do you get $200,000. But let us assume here that even after 1 month, you could get back all your $200,000 equity.

The XIRR at the 300th month if you delay paying a greater down payment is 1.97%. It first dropped from 3.78% to 2.4% to 1.4% in the end of second year before going up.

This has more to do with the irregular nature of the interest payment (larger at the start and smaller at the end)

The XIRR at the 300th month if you use the $200,000 to downpay more is -6.3%. This is pretty crazy. I think the losses were that much because the opportunity was that great.

To give you an idea, after 25 years, the compound interest earned on that $200,000 was $173,000. The total interest expense paid was $35,000.

The conclusion at this point, just don’t increase the downpayment.

Would it be More Sensible to Increase Housing Loan Down Payment if Interest Rate is Higher?

This is a good question to ask.

The most obvious one will be to see if the decision changes if the interst rate is not 1.30% but higher.

Let us take a look.

• Don’t down pay more XIRR: 1.67%
• Down pay more XIRR: -5.42

The results start to narrow.

When you take HDB Loan and incur an Interest Rate of 2.6%

Intuitively, at 2.6% interest, the expense is greater than the CPF OA interest of 2.5% a year.

This may tilt the scale in favor of putting more into down payment.

• Don’t down pay more XIRR: 1.41%
• Down pay more XIRR: -4.63

Looks like it is still worth it after 25 years (300 months)!

But notice that at the start in the first six to twelve months, the XIRR return got very closed.

But even at this point, the total interest expense you will pay is $71,000 versus $173,000 in interest earned from the $200,000 in CPF OA.

Interest Rate of 4% – In Some Situation, it May Make sense to Contribute More Down Payment instead of Dragging Out the Loan

• Don’t down pay more XIRR: 0.79%
• Down pay more XIRR: -2.66

Ok! Now we are starting to see the blue line overlapping the red line. This indicates that in a certain duration, it may make more sense to minimize the loans you take.

The cross over point is about 15 years or 180 months. However, if your loan is 25 years, it would still make sense to not put omre to downpay your home.

• Total interest income: $173,000
• Total interest expense: $114,000

The Interest Rate Which would make more downpayment more worth it: 5.8% a year

If you really want to know at what mortgage interest it will take to make the more downpayment option more attractive, you need to take it to a whopping 5.8%.

• Don’t down pay more XIRR: -0.01%
• Down pay more XIRR: 0.02

• Total interest income: $173,000
• Total interest expense: $173,893

Right at the start, the XIRR for the decision not to downpay more starts working against you.

However, the money in your CPF OA gradually earns more such that you reached the break even point.

What is the Logic Behind This?

I think what worked for not committing more CPF OA to downpayment is similar to why mathematically, you should do lump sum investing than dollar cost averging.

When your returns and interest expense are both certain and you do not expect any volatility, by having more money at the start allows greater compounding effect than if you invest a little by little overtime.

When you choose to contribute more to downpayment, the interest you saved is on the amount of loan left.

As time passes, the amount of loan goes down, so the interest expense saved goes down.

In contrast, your CPF OA earns interest, and as time passes, the interest earns more interest. The power of compounding is very strong.

What May I Have Omitted from my Analysis?

Whenever the math is so befuddling crazy, I start wondering if my model is incorrect.

In this case, I do have a hunch my math is wrong.

If you commit to more downpayment for your home, you also have $200,000 more equity in your home at the start.

This means that if your home value goes up, and you sell off the property, you earn more.

That earns should be factored into my XIRR but I did not.

However, that is an area that is very subjective. How much should I put as the growth rate of the property?

Do I need to do a sensitivity analysis on different property growth rate?

I think if we factor in that equity property growth, I got a sneaky feeling the point where one decision tilt over would be earlier.

This will depend on the growth rate we expect for that property.

What if we are Evaluating Cash instead of CPF OA?

You can just replace the 2.5% return with the growth rate of cash, which is rather low. But if you are an investor, you may be able to earn more than 2.5%.

Your mileage (long term return) will differ based on your sequence of equity return.

Conclusion

The first time I did that analysis of whether it is better to put in more of my income to pay off loans earlier, I got a headache thinking about it.

This time it is more simpler but I think the issue is the same. There are some opportunity costs that is pretty hard to measure.

Some readers might prefer to have a peace of mind when you pay off your loans earlier.

However, I think that you do not have to pay off the loan. As long as you have enough liquidity to last for 3 years of mortgage payments, it may be more than adequate for you to ride out a tough situation.

In the worse scenario, just take the amount that originally was meant to down pay more and pay off a large chunk of it.

Right now, this plan makes more sense because the CPF OA earns 2.5% which is almost 50% more than the interest you can get from bank loan.

The CPF OA is interesting unlike cash in that, you cannot do much with it other than accumulate for retirement, put in investment or pay off your mortgage. With rates low and if you have return options, the decision may be more clear.

If you have another perspective to this problem, do let me know in the comments.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works

Since election season may be upon us, I thought this is a pretty good share.

During this time, we tend to start seeing financial commentators or bloggers trying to show their authority by explaining how the election will turn out and what are the good stocks that will benefit from this.

Then they will pitch you their masterclass courses.

Sometimes, I wonder how much a change in president matters. Based on some of the things that I read about the influence of the presidential election may not be so much. This is because the decision making that would shape policy is not down to one man but also his or her interaction with the senate and congress.

One of my favorites writer Morgan Housel shared something interesting in an interview that he did on a Financial Independence podcast.

Morgan was asked whether the presidential election matters in investing and if it does, to what extent.

Morgan tells the story that in 2010, he has the opportunity to hear a great banking lobbyist talk.

This person have been involved with presidential elections for the past 30 years.

The banking lobbyist made a statement that in every election that he has been involved in, people said that this is the most important election ever. He made a joke that at some point, some of these election stop becoming the most important election ever.

Morgan reflected that he is not immune to this. Back in 2016, he truly felt that the election was the most important one. And today, it feels like this upcoming 2020 election is going to be the most important one.

There is a tendency for the incumbent party to threaten that if the other party wins, the country’s economy will collapse.

Overtime, this have been shown to be not very accurate.

Franklin Roosevelt, the 32nd President of the United States by and large is viewed as one of the most successful presidents of the United States. But back in 1932, his appointment was so controversial.

Many people really thought that his appointment would usher in fascism and communism into the country.

There is also a long tradition of investors saying if this political party wins, by these stocks. These folks tend to have the worst track record of any tradition.

When George. W. Bush won in 2000, there is a very rational narrative that the government will de-regulate the banks, so the smart thing to do is buy the banks. They are also going to do a tax-cut that should benefit the airline stocks.

If you fast forward to 2008, the financial crisis have resulted in the banks and airline stocks going almost bankrupt.

When Barack Obama was elected in 2008, a common narrative was to buy the solar companies because there is going to be a big push for green energy. Within years, most of the solar companies went almost bankrupt.

We all remember that when Donald Trump won, there was a general consensus that this would be terrible for the stock market and the economy.

It is very easy to look back and see all these events turning out to be the exact opposite.

People tend to give the president or the political party on each side more credit, or more blame than they deserve.

The general idea is that, in the list of variables that matter to the performance of the stock market, the president may be so far down the list then we imagine.

Each of us have strong political beliefs but the sound way may be not to let that belief dictate our money management too much.

Morgan explains that if you like your portfolio today in September, you should also be comfortable with this portfolio in November.

By and large, the outcome of this election will matter less to the performance. (If it does affect the performance, it is likely we are looking at it through the short term lens or that we are inferring the wrong things.)

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works

Nowadays, when it comes to mobile plans, our usage pattern varies from person to person.

I used to work in the role of support in a security tight organization. This means that

1. I do not have the internet on my computer terminal.
2. I am constantly on the move.
3. I do not consume a lot of rich media on the go.
4. There will be those occasions I could not plan for that I need to check something technical that I am not too sure about, or that I do not know how to do, or whether it is correct.
5. People do call me and I do need to call people as it is more productive to discuss time-sensitive things through a call.

With these needs, I do need a more dedicated mobile plan so that there is adequate data for me to perform these work functions.

Fast forward to today, for the past 1 year, my usage needs have changed a hundred eighty degrees.

1. Mainly I work from home.
2. I have broadband at home.
3. At work, we have wifi access.
4. I do not consume a lot of rich media content on the go.
5. I do need to call but not so much.

With these kinds of needs, I just need a plan that gives me enough data when I am out and about with my friends and enough talk time for the occasional conversation with people.

So when my M1 contract ran down a few months ago, I began to see which plan on the market that fit these criteria and I hit upon Giga’s $10 a month plan.

Giga is Starhub’s fully digital mobile virtual network operator (MVNO), so they use Starhub’s cell network.

What I like about the plan is:

1. No contract. There is no lock-in. If I do not like the service I can change anytime that I want.
2. $10 a month. One of my goals is to spend only what I need. I think $10 is low enough.
3. 6 GB of Data. When I started with Giga it was 5GB of data and usually, in a month, I would use about 1.5 to 2 GB of data. I know around how much I consume and so are pretty comfortable with this package.
4. 100 SMS. I do not need a lot of SMSes, but I do need some SMS.
5. 100 min talk time. You need some talk time for the occasional call-out.
6. Free Incoming talk time and SMS. This might look like a standard but MyRepublic’s package back then did not include incoming SMS by default.
7. Free Rollover Data. What this means is that if you do not use the data for the past month, it will roll over to the next month. This does not mean that if you keep having surpluses of data, your data would balloon to a lot of GB! Most of the time, I would have 12 GB of data on my plan (it used to be 10 GB in the past)
8. Fully digital onboarding process. This is the first time I experienced a process that I do not have to talk to anyone and I can get a sim card and ready to use within one or two days (I cannot remember). They will give you a temporary number while your existing number is ported from your old telecom operator. I do not know how it works, but I did not experience any breakage in telecom services.
9. Sim card of all sizes. Not sure if you have unpleasant experiences with other telecom operators but the sim card they provided can be broken into different sizes. This means that if you are on a legacy phone that needs to use a larger sim card, Giga would still work without much fuss as well.

With all this, sometimes what I am afraid of is that the 100 min talk time is just not enough. There are some months that may be… some of the support calls that I need to render to some advisers may run longer than that.

The great thing about Giga’s no-frills plan is that if I feel that this is not enough, I could just spend $1 and add 100 mins of talk-time from their mobile app.

This allows me to vary my usage with a base amount of credits.

With the mobile app, I can monitor my usage so that I can add talk-time or data when I need to.

What This Plan is Suited For

I think this plan would fit those who have the same work profile as myself. Work at home or in the office most of the time and not the kind that consumes a lot of rich media.

It just sits at a very nice junction of having flexibility, a cost that is low enough, and flexible.

I like this plan so much that I signed up for my dad to the same plan after being on Singtel for ages.

You may wish to sign up for your parent’s whose calls are mainly incoming, does not call out so much, yet have enough data for their needs.

This might also be suitable if you have the kids and wish to control their usage, yet don’t have an autocratic plan that will be very hard for you to increase their usage if there are peak periods where they need more communication with their friends.

I do read a lot from website on the go in the past while I am in my IT job and seldom did I get into a situation where my data usage just based on reading websites rich in media goes above 5 GB.

In terms of network, Starhub’s network is not the best. I always had this reservations whenever I have friends complaining about the network but I got round to the idea that each telecom network has a weak point in certain regions. You just have to know whether these network are weak for the regions that you will frequent.

I have used their network for a while and I think it is serviceable. Never did it got to a stage where the thought of cancellation and switching came to my mind.

Where to Sign Up

Giga does have other no-contract plans on the higher tier, and if your needs are higher, you might want to go for them. I am not sure if it is getting popular to not have home broadband and just sign up for a jumbo mobile plan, but the 45 GB one might interest you (do let me know in the comments if, for your family, you choose only to sign up for mobile packages without a home broadband package.)

If you would like to sign up for Giga, you can use my Referral Code: bVW331

If you sign up with my referral code, you get to enjoy the Top Pick 45GB plan at just $15 (U.P. $25) for the first month. Or enjoy the 6GB plan at just $9 (U.P. $10) for the first month or 50GB plan at just $42 (U.P. $45) for the first month.

Enter the referral promo code bVW331 on the payments page when you sign up for Giga.

If you do not like it, remember that it is no contract and you can cancel anytime.

This post contains affiliate links. Kyith gets paid just a tiny amount when you sign up. Like half the price of a Starbucks coffee tiny.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works