What is MPF? From company-guaranteed pensions to self-reliance

This article is a rewrite of a report from February 2012.

Retirement schemes come in two flavours: defined-benefit plans, where the company manages the money and guarantees the payout — like Hong Kong’s civil-service pension — and defined-contribution plans, where employees run their own pot and live with the outcome. The MPF is firmly the latter, with one constant: employer and employee each contribute 5 per cent of relevant income every month.

What is MPF?

The MPF is Hong Kong’s mandatory provident fund system, with employers and employees each making mandatory contributions equal to 5 per cent of relevant income every month. It is a defined-contribution scheme: there is no company backstop, so what you retire on depends entirely on investment performance — leaving workers to underwrite their own retirement, which makes managing the portfolio essential.

Why companies stopped guaranteeing pensions

Defined-benefit plans are dying out for a simple reason: earning enough to fund guaranteed payouts keeps getting harder. Large S&P 500 companies needed average annual returns of 9.1 per cent a decade ago, and still need 7.8 per cent today; with bonds yielding an average 2.2 per cent a year, equities would have to earn 13.4 per cent to make up the difference — near-impossible in prevailing markets. Forty-two companies ended up injecting an average US$250 million each last year to top up staff pensions, pushing more firms to switch systems.

Warren Buffett’s two tricks

Some companies still run defined-benefit plans — Warren Buffett’s Berkshire Hathaway among them — using two tricks to ease the burden. First, lower expectations: a 7.1 per cent average annual return suffices. Second, a 70-30 equity-bond split: the heavy equity weighting works because US equities have averaged 8 to 9 per cent a year over the very long term, compensating for bonds’ meagre returns.

Why Hongkongers must be bolder

Hong Kong’s position is tougher still: MPF managers charge on average more than one to two per cent, enough to wipe out guaranteed and bond funds after fees. That leaves Hong Kong equity and other aggressive funds as the only viable options — with no one to backstop you, choosing well and managing actively is the only way.

For the basics of managing your MPF, see the MPF education guides.