IN general, most people have the impression that the money placed in the Employees Provident Fund (EPF) always generates lower returns compared with the returns from their own investments.
In this article, we will look into the returns from EPF versus returns from the KL Composite Index (KLCI). We assume that investors are able to generate their own returns equivalent to the returns from the KLCI.
Based on our 23 years of data compilation, it is generally true that the average returns generated from EPF are lower than KLCI returns. From 1986 to 2008, the average return of EPF was 6.7%, 2.3 percentage points lower than the average return of 9% from the KLCI (see table).
However, most people do not understand the risks they need to undertake when they invest by themselves. The standard deviation of EPF is only 1.5%, 22.2 percentage points lower than the standard deviation of 23.7% from the KLCI.
We use standard deviation to measure risks. Most investors only look at how to generate the extra 2.3 percentage point returns, forgetting that they need to undertake a much higher risk to generate the extra returns. The extra return is unable to compensate for the extra risks that investors need to take.
Let’s assume one investor invested RM10,000 in the EPF and the KLCI respectively at the beginning of 1986. Logically with the average KLCI return higher than the average EPF return, the fund in KLCI should be higher than the fund in EPF in most periods.
However, as the table shows, by the end of 2008 (we assume that EPF will only be able to generate a return of 4.25%), the fund placed in KLCI would have reached RM40,000 versus RM43,946 generated by EPF, a shortfall of RM3,946.
The main reason behind this shortfall is that the EPF never gives negative returns whereas the KLCI generated negative returns eight times over the past 23 years.
There is a market saying that out of 10 people who invest in the stock market, only one can make money, the others will lose money. Warren Buffett says if you want to win, you don’t lose. Hence, we disagree with some people who advise others not to place money in EPF because it generates lower returns.
In most periods, the money in EPF gets lower return than the money placed in KLCI. However, the main reason for the lower fund value in KLCI by the end of 2008 was the market crash during 1998.
The money in KLCI dropped by 47.1% to RM18,105 in 1998 from RM34,246 in 1997 whereas the money placed in EPF increased further to RM26,594 in 1998 from RM24,924 in 1997. After 1998, it took nine years for KLCI to catch up with the fund value in EPF.
Last year the fund value in KLCI (RM46,000) finally surpassed the fund value in EPF (RM42,154). However, as a result of the recent market crashes, we are anticipating the fund value in EPF to overtake KLCI again this year.
It will take a few years from now for the KLCI to catch up with the EPF again. Unless investors are constantly monitoring their own investments and are able to avoid most of the negative returns, we think it is safer to put money in the EPF rather than withdraw it for their own investments.And then another news that kinda contradicting with the earlier news out........
EPF Q3 investment income down 60.4% to RM2.06bLinks over here
See how contradicting? Not totally contradicting, since EPF not really losing any money but the fact remains that EPF's earning will suffer as well during the financial turmoil or recession. We can argue forever and say that the Government promises us at least 2.5% return (Wikipedia is the man) without risk. But how sure are we that the EPF will give a return of > 3.5% (comparing to the FD rates). If during recession (worst case) EPF only give return of 2.5%, then it is lower than the current FD rates in Malaysia. Worse still, it is way below the current inflation rate of 7.x% (provided by Bank Negara, but we all know it is a lot more). What about equities, in our case KLCI? Will it always return lower or negative return? I will continue to discuss on Part 2 when I have time. In the meantime....think about it yourself. "Is EPF really better than KLCI?"