A look into the Malaysian Employees Provident Fund (EPF)


Dear Readers
Before I begin, I would like to place a caveat in this article: this article is based solely on my opinion.
The recent downfall of crude oil prices has revealed the vulnerability of the Malaysian economy to the movement of crude oil prices and its reliance, to an extent, on oil money, to fund fiscal policies. Acting in tandem with crude oil prices is the valuation of the Ringgit; Ringgit’s fate is usually sealed alongside the fluctuation of crude oil prices.

Credit: USA Today

Because of the drop in the valuation of Ringgit compared to the US Dollar, import items and commodities (generally traded in USD) are more expensive. This effect has driven the increase of prices of everyday items. This consequently drives inflation up.

Is inflation good?

Inflation is, as Banjamin Graham puts it, “shrinkage of purchasing power”. In other words, the value of your money decreases over time. This explains why a bowl of yummy noodles which costed RM2.50, 10 years ago, is now RM4.00.

However, inflation, when viewed in a macroeconomics point of view, is preferable over deflation. Deflation is the opposite of inflation; where the value of money increases because prices of goods and services decrease over time. You may be thinking,  wouldn’t it be better if my money increased in value every year? Well, not necessarily, because that means you, me and every other humans, would hold off on purchases for the reason that things will get cheaper in the near future. As a result, businesses will suffer tremendously because of the lack of sales. When businesses suffer, so do employees who make up a bulk of consumers.

Having explained the vicious deflationary cycle, it is easy to see why deflation is bad for the health of the economy. Certainly, excessive inflation is not good either –  look at the mess that it had created in Zimbabwe and Venezuela. Hence, central banks are tasked to strike a delicate balance between an inflation which is sufficient to stimulate the economy but would not burden consumers.

Recently, inflation has been a hot topic among Malaysians. This is because inflation has been on the upper-side since the beginning of 2017. In fact, inflation in September 2017 hit 4.3% but eased in October 2017, at 3.7%. I believe that the average inflation this year will be above 3%.

How will inflation affect your savings and investments?

You are all savers and investors as soon as you start earning an income. Most of your first investment is mandated in the form of EPF. EPF doubles as a savings account and an investment account for your retirement. The saving component is derived from the mandated contribution into your EPF, at the rate of between 11% to 8%. Of course, your employer co-contributes between 12% to 13%, depending on your salary.

The investment portion of EPF is achieved by the payment of dividend declared by EPF every year and the reinvestment of that dividend. The effect of the reinvestment of that dividend will be compounded over time until your retirement age is reached. Through savings and investing, it is hoped that you will be able to build a decent nest egg.

Because inflation decreases your value of money over time, your savings and investment in EPF will also be effected.

Malaysia’s average inflation in 2016 is about 2.1%. At the same time, EPF dividend return in 2016 is at 5.7%. That means there is a 3.6% actual growth in our savings and investment in EPF. If all things being equal for the foreseeable future and you no longer contribute to EPF, a 3.6% actual growth means that it will take 20 years for your investment in EPF to double (compounded of course). For example, RM100,000 will become RM200,000 in 20 years. In another 20 years (40 years in total), RM200,000 will become RM400,000.

However, if the actual growth is 5%, with all things being equal for the foreseeable future and you no longer contribute to EPF, it will take you 14.4 years to double up your money in EPF (compounded). For example, RM100,000 will become RM200,000 in 14.4 years. In another 14.4 years (about 29 years in total), that RM200,000 will become RM400,000. In another 11 years (40 years in total), that RM400,000 will become roughly RM714,285.

This illustration, although superficial, shows how a difference of 1.4% (5% – 3.6%) in actual growth, compounded over a lengthy 40 years, could affect your nest egg greatly.

Is EPF doing enough?

It is quite resounding that the majority of Malaysians do not have enough retirement savings. Two thirds of EPF members age 54 have less then RM50,000 in EPF savings. This is due to many factors including the lack or inability to save money, and possibly the low dividend yields declared by EPF.

As illustrated above, even a net growth of 1.4% can do wonders over time. So is it that hard for EPF to yield a 7% dividend yield per year? Personally, I think a 7% dividend pay out per year is not far-fetched or beyond the realm of possibilities (of course not in a financial crisis which has global implications).

EPF, in my opinion, would have to allocate more fixed income investment (which it holds about 51% in 2016) to more dividend-yielding equities (about 42-43%). Because Malaysia is a small economy, there are only so many quality blue chips, bonds and real estate to go around. Hence, it only make sense to invest in overseas assets. In 2016, EPF has 29% of overseas assets which yields 39% of gross investment income. It is important to note that Norwegian’s sovereign fund, the largest in the world with USD 1 trillion in assets, invest as much as almost all of its assets overseas. This is because Norway has a very small population and economy.

I’m sure EPF is aware that overseas market is providing better yields especially when our local market which had seeing red between 2014 to 2016. On the other hand,  the Dow Jones, Nasdaq, Nikkei and Hang Seng are hitting new recent highs.

However, nothing is as simple as it seems especially when there are other factors which may influence EPF’s investment decisions. Government interference may be one of those factors. Section 11 of the Employees Provident Fund Act 1991 allows the government to give the EPF Board directions as to how the Board performs its functions and duties. Those directions must be adhered so long as they do not go against the EPF Act. The government’s influence in EPF can be seen when Prime Minister made a promise that EPF will invest in American infrastructure. That raised a lot of controversies. But at the same breathe, isn’t it good that EPF is seeking to invest overseas instead of Malaysia?

So, what do we want?

Maybe it is time to reform our pension scheme. Maybe it is time to do away with a pension system like EPF. Maybe it is time to introduce a superannuation scheme.

Instead of making it compulsory to invest in EPF, you are required to invest in superannuation schemes which is similar to the Private Retirement Schemes. That way, you have control over your investment through a multitude of investment funds, and at the same time, developing the local financial industry to service this sector. There will be little or no government intervention into the way your money is invested and you are the master of your destiny.

So what are your thoughts? Should we move away from EPF? Or is EPF is reasonably good and flexible as it allows you to withdraw a portion of your EPF to be invested in EPF-compliant funds? Are there other pension schemes which you would like to share?

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