The importance of staying active: Investing for retirement in uncertain times

The era of reliable investment returns appears over, at least for the foreseeable future, and that poses significant challenges for retirees in Asia. COVID-19 has made matters worse with a low-interest rate (and, in some countries, a negative-interest rate) environment coupled with low bond yields, and has all but guaranteed an uncertain trajectory for stock markets. 

Ongoing monetary easing in many countries means interest rates will likely stay low for years. At the same time, the economic environment has seen many firms reduce or eliminate dividends, which for years provided retirees with an important, dependable income stream.

These factors have compounded existing worries about a retirement savings gap, while certain actions by governments to counter COVID-19’s economic effects have added to the long-term challenge. Some countries have let people contribute less – Malaysia, for example, said employees could decrease their mandatory contribution.¹ Other efforts include deferring planned hikes in public pension contribution rates (Singapore) and letting people draw down from their personal pension plans (South Korea).²

Deferring planned hikes and allowing access to saved funds are sensible short-term solutions that help people to pay mortgages and meet key needs. But they also mean savers are mortgaging the present as they will have less in their retirement pot and will miss out on compounding – which can significantly reduce retirement income. 

This paper examines the long-term macroeconomic factors we believe will affect retirement-focused investments in the coming decades. In particular, we analyse how they will affect investment returns across a range of asset classes that comprise basic retirement portfolios. 

That allows us to show what this means for investors and, through hypothetical modelling, calculate the investment and income needs of pre-retiree couples in Hong Kong and Singapore, and recommend courses of action.

Even before COVID-19 roiled global asset markets and increased investment uncertainty, Asian retirees faced significant retirement challenges that threatened to widen the existing retirement gap in many markets. Those fall into three broad categories: demography and a lack of savings; inflation and the allocation of pension assets; and issues related to the economy and its recovery.  

Pension systems are under pressure from the unprecedented pace of demographic change sweeping the region. While Asia’s overall population is estimated to grow 19 percent between 2015 and 2050, its population aged 60+ will increase almost 150 percent.³ China and India could see their elderly populations double.

One driving factor is that people are living longer. Medical advances, healthier lifestyles and a decline in communicable and non-communicable diseases have increased life expectancies across the region. Between 1975 and 1980, the average life expectancy for 60-year-olds was 16 years. Today, it’s expected to reach 23 years by 2050-2055, meaning the average Asian will live well into his or her 80s. In markets like Japan, Hong Kong, Singapore and South Korea, it’s estimated that half of the population will live beyond 90, spending decades in retirement.⁴

Another factor is low birth rates. Of key Asian markets, only India has a birth rate above the threshold of 2.1, which is considered sufficient to sustain a stable population.⁵ Birth rates for Japan (1.33), Singapore (1.26) and South Korea (1.24) are among the lowest in the region.⁶ At 1.53, China’s birth rate in 2019 was at its lowest for decades.⁷

As a result, the proportion of the working-age population to retirees is shrinking, putting an enormous funding strain on the region’s pension systems. What’s uniquely challenging for Asia, however, is the pace at which the transition is occurring, which is three to four times faster than most developed nations. This means that what typically occurs over a century elsewhere is happening within a single generation in Asia (see Chart 1). The economic tailwind of having a growing working population has reached an inflection point and is slowly becoming a headwind. 

In the future, there will be far fewer working people supporting the elderly. Under current scenarios, the pension systems of most markets won’t be able to provide adequate income replacement for retirees. That has put pressure on those systems to ensure long-term sustainability. 

At the same time, many people in these fast-ageing nations fear they don’t have enough saved for their retirement. While it’s true that most adults across Asia have taken steps towards retirement planning, it’s also the case that their confidence in the effectiveness of their savings is low: fewer than half believe they have enough savings to last until the end of their retirement.⁸ Confidence is especially low in Hong Kong, South Korea and Japan where 37 percent, 33 percent and 20 percent respectively believe they are covered.

One issue is that roughly one-fifth of workers lack access to a retirement plan with their current employer.⁹ Employer-sponsored defined contribution plans can provide a valuable pathway to supplementing state-run pension systems – and also serve as a medium for delivering sorely needed financial education, given that most Asians do not work with a financial advisor or have a formal written plan for managing income, assets and expenses in retirement.¹⁰ A remarkable 50 percent of Singaporeans do not have access to an employer-sponsored retirement plan although, as we’ll see later, Singapore’s state-run programme is a model for the region. Even when employer-sponsored plans are in place, a sizeable proportion of people don’t take advantage of them: across Asia, about two-fifths of employees do not contribute to their workplace retirement plan.¹¹

An additional consideration is the rise of the gig economy, where Asia is a front-runner. This profound change in the world of work requires yet more financial preparation.

Inflation is another challenge, eating into retirement savings or wealth, and leaving less for retirees. Inflation is even more important for retirees as it is typically higher for the basket of goods and services that they tend to purchase like healthcare, housing and food. 

Take healthcare for example. In most surveys that seek to understand the cost for employer-sponsored medical plans¹² in Asia Pacific, it’s common to find that the net annual medical trend rates exceed 5 percent on top of 3-4 percent general inflation. This figure could serve as a proxy to understand the inflation implications that people without employer-sponsored/subsidised programs could face when it comes to healthcare goods and other treatments. 

Additionally, some people might not realise that their health insurance premiums will increase as they age. For example, referencing products in Hong Kong and Singapore shows that people in their mid-50s usually face a higher insurance premium rise than those who are younger. In Singapore, the typical premium increases by 50-70 percent per decade of ageing.¹³ As a result, a less robust investment or savings plan would consume more retirement savings, which could impair the budget-planning that people do for retirement. 

Complicating this further is the cash-heavy asset allocation of the typical investor in the region. In our most recent Manulife Investment Sentiment Index (MISI), the surveyed affluent households in Asia¹⁴ held 37 percent of household assets (excluding the value of the primary residence) in cash, with another 23 percent in stocks, mutual funds and ETFs (see Chart 2¹⁵). A further 19 percent are held in insurance products, and 5 percent each in fixed income investments and real estate as an investment. While numbers fluctuate by market, cash is the most popular asset choice in every case. An environment of inflation and near-zero percent interest rates means the real value of that cash will diminish each year.

It’s not hard to see why retirees in countries across Asia face a perfect storm. That’s particularly true for people who are already retired or who are, say, five or ten years away from starting to draw a pension. After all, the closer to retirement people are, the more they need cash flow – not exposure to buy-and-hold stocks that younger investors focus on for capital appreciation over decades. Those challenges will be further compounded as traditional family support for the elderly declines.

The OECD views the region’s crucial pension challenges as, “rapid population ageing and low coverage, both for those receiving benefits and those contributing to the pension systems”.¹⁶ And, it points out, enacting reforms is politically difficult, “as it often entails unpopular measures, such as increasing the retirement age, lowering benefits or increasing contribution rates”.¹⁷

The OECD drew those conclusions well before COVID-19. The current economic environment means making the necessary changes will be even harder. It’s also unclear whether matters will improve much in the years ahead. The IMF concluded in late 2020 that Emerging and Developing Asia would contract 1.7 percent in 2020 (though China would see growth of 1.9 percent).¹⁸ Looking ahead, the IMF expects growth in Emerging and Developing Asia to rise 8 percent in 2021, with China expected to grow 8.2 percent – though it cautions that, on a global view, there is “tremendous uncertainty around the outlook with both downside and upside risks”.¹⁹

That’s important because, as the IMF noted earlier in the year, Asia’s economic growth is directly linked to global supply chains – so weak demand elsewhere will impact economies here too.²⁰ In any event, Asia’s economic output would be markedly lower in 2022 than it would otherwise have been, the IMF said – “and this gap will be much larger if we exclude China, where economic activity has already started to rebound” (Chart 3).²¹

All of these factors will compound the difficulty of closing the retirement gap, which is already wide in a number of Asia-Pacific economies and which is set to grow further. And the challenges don’t end there. Another is that, going forward, assets traditionally regarded as safer could provide lower returns for conservative investors as a result of the global pandemic and related economic shutdowns.

In our view, this condition will likely persist for some time, not least because central banks across the region lowered policy rates in 2020 to buffer economies from the loss of global trade, tourism and other COVID-related setbacks. 

Those actions have had a direct effect on bank deposit interest rates – with deposits, as we’ve seen, constituting a crucial holding across Asia. Real deposit interest rates (the interest rate after inflation) in China, Hong Kong, Japan and Vietnam are all below zero percent (see Chart 4²²), which makes it impossible to generate income replacement from these sources. 

Looking ahead, several factors will contribute to a deflationary environment, including an ageing demographic, rising debt and ongoing digitalisation. We’ve incorporated those aspects into our forecasts, but we also recognize that the combined impact of significant monetary and fiscal easing by governments – not to mention a global supply-side shock – will likely have an inflationary effect in the coming decade.

Ongoing quantitative easing (QE) by central banks, in which they buy government debt to inject cash into the economy, is pushing up the prices of longer-dated bonds and pushing down yields. Six Asian central banks announced QE-like government bond-purchasing programmes in 2020, according to the Institute of International Finance, and bond yields are lower across the board.²³ In fact, yields are lower than average yields of the past 10 years (see Chart 5), which means investors with sovereign bonds as fixed income holdings in their retirement nest egg are yielding less and less. This implies investors will need to get used to the idea that interest rates will likely stay at, or below, zero percent for the foreseeable future. 

In summary, retirement savers in Asia faced several challenges heading into 2021, including demographic changes that will put pressure on pension systems, a perceived savings gap, and a preference for conservative fixed income vehicles and cash. Now, in response to the pandemic, central banks are putting pressure on those very sources of income. 

In the next two sections, we’ll take an in-depth look at two markets, Hong Kong and Singapore, to examine these challenges in greater detail through historical data analysis and try to understand the probability of a shortfall for retirees there. 

Hong Kong and Singapore have much in common. Both began their rise as ports and both leveraged their advantage in trade to become financial powerhouses, along the way providing their citizens with some of the best quality-of-life metrics in the world. 

Less well-known is that both set up successful pension funds: MPF and CPF. Both funds operate by defining contributions and making them mandatory for most workers, and both are among the world’s largest public pension schemes.

When it comes to their beneficiaries, residents of both places face common challenges including declining rental yields (with rising property prices) and steepening inflation in areas like healthcare and housing. Those issues raise questions about how to sustainably finance a minimum or comfortable livelihood after retirement. 

As we shall see, there are also important differences between both places in terms of their public and private arrangements which offer useful lessons for their neighbours.

Hong Kong’s Mandatory Provident Fund (MPF), which started life 20 years ago, requires a 5-percent compulsory contribution from employers and employees, with those contributions handled by asset managers. The MPF covers nearly three million people – the vast majority of working-age Hongkongers – and recently crossed HK$1 trillion in assets, with a strong recovery in equity markets helping its account balances following a pandemic-related drop. The MPF is now the eighth-largest pension fund in Asia and on track to be in the top 20 worldwide.²⁴

Additionally, as a relatively new scheme, the MPF incorporates numerous best practices for international pension fund management and governance. It is, by many measures, a regional and global success. Despite that, Hongkongers still face challenges as they try to close the retirement savings gap with MPF and other retirement plans.

Asset allocation in the saving years

The ability to choose from hundreds of investment options gives MPF members great flexibility and control in how they manage their financial futures. Members must understand which investments make the most sense for their age and financial situation. Investments with too much risk near retirement age can irreparably reduce an account balance once withdrawals begin, while investments that are too conservative can fail to generate enough retirement income for residents of the famously expensive city. 

A default investment category introduced in 2017 seeks to balance these risks by diversifying across equity and fixed income, and automatically becomes more conservative over time. Although only 15 percent of MPF accounts are invested in these default investment strategies, they are slowly gaining broader appeal.²⁵

Today, the largest weighting across MPF accounts is in equities. In fact, nearly two-thirds of account assets are invested this way, either through pure equity funds or mixed-asset funds that favour equities.²⁶ This combination of equity funds and mixed-asset funds remains fairly steady in investor accounts across age groups, with the proportion of pure equity funds dipping only in the years immediately before retirement age. 

MPF members also tend to invest locally, with 62 percent of total assets invested in Hong Kong-based funds, followed by North America-based funds at 17 percent.²⁷

Although the annualised return of the MPF system over the past decade is only 3.8 percent,²⁸ individual situations can vary widely depending on fund holdings and holding periods. The MPF Schemes Authority is quick to stress the importance of treating MPF holdings as long-term investments. Too many investors fall into an emotional pattern of switching out of funds after they have declined in value due to market dynamics, only to switch back in after they rebound.²⁹

Reinvestment rates in retirement

One important behavioural dynamic of MPF scheme members is their overwhelming preference for taking a lump-sum withdrawal at retirement at age 65: some 98 percent do so, while just 2 percent opt for a schedule of instalment payments.³⁰ There are two risks associated with the first approach. First, a saver might hastily spend a lifetime of savings unwisely, leaving few options for retirement income. Second – and more likely – he or she risks reinvesting the proceeds in lower-yielding assets in withdrawal phases.

One example is reinvesting those proceeds in property, which has traditionally been a popular asset class in Hong Kong representing a tangible asset with the potential for capital appreciation and an inflation-protected source of income. However, rental yields – taking into account the cost of ownership – have fallen steadily in recent years as property prices have surged (see Chart 6³¹. Across different-sized properties, the average annual rental yield over a decade is just 2.9 percent, some way below the 10-year annualised inflation rate of 3.02 percent.³¹

Another popular option for Hong Kong retirees is cash, but at 0.02 percent, the 10-year average savings deposit rate does little to protect against rising costs in retirement. Recent declines in central bank policy rates across the region to combat pandemic-related economic slowing have only cemented the reality of near-zero yields on deposit accounts far into the future.

Other popular tools for retirement

Rental properties and bank deposits are two options. Another is to purchase financial products that generate a retirement income. Indeed, there’s a stronger preference towards products that provide a guaranteed lifetime income.³² One such example is an annuity:³³ the Hong Kong Mortgage Corporations launched the HKMC Annuity Plan in mid-2018 to cater for the needs of elderly, cash-rich residents. The expected monthly pay-out for males at the entry age of 65 would be HK$580 per HK$100,000 premium paid, while for females, the monthly pay-out would be around HK$530 due to their longer life expectancy. The following year, several insurance companies launched a “tax-deductible” qualifying deferred annuity policy (QDAP) in Hong Kong – with the tax-deductible element being the key incentive. More options have emerged in 2020 – for example, an income-oriented product that allows MPF members to stay invested upon their retirement with a drawdown benefit, and with a regular income stream that aims to beat inflation.

Rising retirement cost

Beating inflation, of course, is crucial. However, as we’ve seen, Hongkongers may struggle to earn even 3 percent annually from a variety of investment options – and retirement-related expenses can easily rise faster than that. In the decade to 2019, for example, the average inflation rate was 3.02 percent³⁴, so at a glance a 3-percent return looks manageable. However, that overall figure masks higher rates of inflation in categories that dominate retiree budgets like food, housing and medical costs. Indeed, housing and medical costs in particular rose at an annualised rate of 6.83 percent and 8.1 percent respectively.³⁵ As we shall see, the challenges facing retirees in Hong Kong have parallels with their peers in Singapore.

Singapore’s pension system is one of the oldest and most developed national schemes in Asia. Established in 1955, the Central Provident Fund (CPF) that administers the system was originally a savings scheme for home ownership, with modest amounts set aside for retirement. However, the government began tweaking the system in the mid-1990s as Singaporeans’ incomes grew. With most people owning their homes, the CPF’s focus switched to boosting cash savings for retirement. Limits were imposed on withdrawals for housing, and the CPF’s savings interest rates were raised. 

The CPF features high contribution rates by employees (17 percent of wages) and employers (20 percent), though those are relaxed after age 55, and has a range of accounts and investment options. Lastly, it is centrally managed: pension savings are handed to the government and commingled with state funds, which make a return by investing in assets worldwide. 

An attractive – and guaranteed – rate of return

Unlike in Hong Kong, where almost all members choose to take a lump-sum withdrawal at retirement, 42 percent of Singaporeans stay invested in the CPF after reaching 55, which is the minimum age for taking withdrawals.³⁶

One reason members remain is the relatively high guaranteed rate of return on savings. By default, the government guarantees 2.5 percent interest on savings in the CPF Ordinary Account (which is meant for housing, insurance, investment and education) and 4 percent on savings in the CPF Special Account (for old age and investment in retirement-related products). The Ordinary and Special Accounts are automatically combined into a Retirement Account when an individual reaches 55; that combined account benefits from the 4-percent return guarantee. From 55, CPF members earn an additional 1 percent interest on the first S$30,000 of their combined balances.   

In fact, only 13 percent of active CPF members elect to invest outside of these guaranteed savings accounts, which they do through the CPF’s Investment Scheme (CPFIS). This allows them to invest their CPF Ordinary Account and Special Account balances in various investment products such as stocks, bonds and unit trusts (mutual funds). Returns from these investment options have been mixed, with some outperforming the programme’s guaranteed savings rates and others failing to keep pace. It’s safe to say that on balance these in-plan investment options haven’t generated the kinds of returns that would convince Singaporeans to leave their guaranteed return accounts behind.

Who does the CPF money belong to?

While Hong Kong’s MPF comprises each individual’s pension account, the CPF is a collective social savings pool. It’s why the question of “Who does the money belong to?” comes up often in Singapore but not in Hong Kong. From age 55, members’ CPF savings are transferred to their Retirement Account (RA) up to the Full Retirement Sum (FRS) of S$181,000. After setting aside the FRS fully with cash, or with property and cash (i.e. S$90,500 which is the Basic Retirement Sum), members can choose to withdraw the remaining cash balances in their Ordinary and Special Accounts. Setting aside a retirement sum (Full or Basic) when members reach 55 allows them to receive a regular monthly income (S$1,390-1,490 or S$750-810, based on CPF Life Standard Plan and computed as of 2020) from 65 until 90 through CPF Life, a mandatory deferred annuity scheme introduced in 2009. However, Singaporeans are not free to use a large sum of their retirement savings from the CPF account: some criticise the government for “locking up” their money and want it “returned” so they can use it as they deem fit.

Options for retirees don’t measure up

With Singaporeans living longer, citizens must make decisions about how to manage their savings for what might well be decades of retirement. The most recent survey by Manulife found that, besides the CPF, savings and investment returns are the other important sources of retirement income among Singaporeans (see Chart 7³⁷). However, their returns aren’t always as favourable.

Investing in income-producing property offers a good example. As in Hong Kong, the rental yield in Singapore has declined as property values have increased over the past decade. In 2019, the rental yield of a 75-square-metre apartment in the Central Core region was just 3.28 percent.³⁸ Bank account interest is another example: deposit interest rates from banks have been low for years, averaging 0.13 percent for the 10-year period through 2019, according to Bloomberg.

At the same time and like Hongkongers, Singaporeans are facing a situation in which certain costs are climbing much faster than the overall inflation rate, which is a relatively tame 1.56 percent (using a 10-year average). Take property rents and property prices: both have risen faster than the general rate of inflation, climbing 1.75 percent and 2.78 percent annually respectively over the past decade.³⁹

However, the biggest concern for retirees is healthcare costs. A 2020 report by AON showed medical costs rising at a rate of 10 percent per year due to higher costs for healthcare goods, a growing elderly population, increasing levels of stress and other issues.⁴⁰

There is a direct link here to the healthy life expectancy (HALE), which measures the number of years that a person of a given age can expect to live in full health, taking into account mortality and disability. The trend shows that Singaporeans are spending more years in poorer health: life expectancy was 83.9 in 2019 but the HALE metric was 73.9. In other words, poor health resulted in a loss of 10 years of healthy life (in 2015, that figure was eight years).⁴¹ As the population ages, Singapore’s retirees may need to look for alternatives beyond their CPF guaranteed rates of return and existing options.

Different cities, similar challenges

In a nutshell, then, while both Hong Kong and Singapore offer enviable developed pension systems, members of the MPF and the CPF lack protection against longevity- and retirement-related inflation risks. What does this imply for retirees? In the next section, we will run a simulation to assess the likelihood that individuals will face a retirement savings shortfall in these two high-income financial centres.

24 Hong Kong’s MPF hits HK$1 trillion (US$129 billion) mark for first time, thanks to rally in investment markets, says head of pension regulator, SCMP (September 6, 2020). See: https://www.scmp.com/business/banking-finance/article/3100430/hong-kongs-mpf-hits-hk1-trillion-us129-billion-mark-first. 25 Mandatory Provident Fund Schemes Statistical Digest, MPF Authority, June 6, 2020. 26 Investment Performance of the MPF System in 2019, MPFA, 2020. 27 Ibid. 28 Annualised returns from 31 December 2009 to 31 December 2019, in Hong Kong dollars. 29 Ibid. 30 Mandatory Provident Fund Schemes Statistical Digest, MPF Authority, June 6, 2020. 31 Hong Kong Rating and Valuations Department, rental yields over the past decade, as of 2019. Global Property Guide, 2020, 10-year average rental yield, 40-69.9 square meters, from 2009 to 2019. https://www.imf.org/external/datamapper/PCPIPCH@WEO/OEMDC/ADVEC/WEOWORLD. 32 Spotlight on Retirement Asia, 2018. 33 For an immediate annuity, the annuitant starts receiving an annuity income once the premium has been paid up in a lump sum. For a deferred annuity, the annuitant contributes and accumulates capital to build up an income stream for retirement. The insurance company invests the capital during the accumulation period and starts to pay the annuitant after a certain period, or at a specified age of the annuitant. 34 International Monetary Fund, as of 2019: https://www.imf.org/external/datamapper/PCPIPCH@WEO/OEMDC/ADVEC/WEOWORLD. 35 Rating and Valuation Department; Global Medical Trend Rates, Aon Hewitt. 36 What do CPF members do with the cash withdrawals from their CPF after age 55? CPF Trends, August 2018. 37 Manulife’s “3-Generation survey”, 2018. 38 You wouldn't own a Singapore condominium for rental yields! Global Property Guide, June 15, 2019. 39 HBD resale price index, SRX Property Index. 40 2020 Global Medical Trend Rates, AON, 2020. 41 Global Health Metrics: Global age-sex-specific fertility, mortality, healthy life expectancy (HALE) and population estimates in 204 countries and territories, 1950-2019: a comprehensive demographics analysis for the Global Burden of Disease Study 2019.