You will be able to explain why risk questionnaires can overstate how much loss you can bear.
When Hui Min opened her robo-adviser account three years ago, a questionnaire asked how she'd react if her portfolio fell 20% in a year. It was a quiet Sunday afternoon, markets had been rising, and she ticked "I would buy more". The platform put her in a portfolio with most of its money in shares. A year later, in a bad few months, her account fell about 15%. She didn't buy more. She stopped her monthly contributions for four months and came close to selling everything.
Risk questionnaires ask you to predict how you'll feel and act in a situation you're not in. People are not good at that. When you're calm, it's hard to imagine how strongly you'll feel when you're frightened, and you tend to underestimate how much the fear will change what you do. Psychologists sometimes call this a hot-cold empathy gap: the calm, "cold" version of you misjudges the stressed, "hot" version.
So a questionnaire filled in on a good day can overstate how much loss you can sit through. There is also some evidence that people's answers to risk questions shift with markets, with people sounding braver after rises and more cautious after falls. That means the questionnaire can capture your mood that month as much as your actual tolerance.
None of this makes questionnaires useless. They're a sensible starting point, and in Singapore advisers and platforms are expected to assess your risk profile before recommending investments. Treat the result as a first estimate, made by the calm version of you, that the stressed version will have to live with.
The questionnaire asked about 20%. Hui Min's account showed dollars. A fall described as a percentage is abstract. The same fall shown as a smaller number in your own account, with the amount gone sitting next to your salary in your mind, can feel much worse.
Investing 101, lesson 7.3, What a market fall looks like in your own account, works through this conversion in detail, using falls of 20%, 30% and 40% on a balance you expect to have. This lesson adds the behavioural point: the dollar figure is the one your stressed self will react to, so it's the one your calm self should plan around.
The same fall can also feel different depending on how much you have invested. Losing 30% of S$5,000 is S$1,500, roughly a nice holiday. Losing 30% of S$150,000 is S$45,000, which might be more than a year's take-home pay. Many people find their nerve shrinks as their portfolio grows, even though the percentage risk hasn't changed. That's worth knowing while your balance is still small.
The practical step is to translate a realistic fall into dollars on your actual portfolio before you decide how much to hold in shares. Broad share markets have fallen by about a third or more several times in recent decades, so a fall of one third is a reasonable test rather than an extreme one.
Take Hui Min's portfolio, with example figures. It's worth S$60,000. If all of it were in shares and shares fell by a third, she'd lose S$20,000 on paper. With 80% in shares and the rest in bonds and cash that held their value, she'd lose S$16,000. With 60% in shares, she'd lose S$12,000. Real bonds don't always hold steady in a fall, so treat these as rough.
Then she asked herself which of those numbers she could watch for a year without selling or stopping her contributions. She used her past behaviour as evidence rather than her hopes: she'd already stopped contributing during a 15% fall, which was about S$6,000 on her balance at the time. That suggested S$20,000 was well beyond her and that even S$12,000 would test her. She settled on something nearer 60% in shares for now, and wrote that she'd revisit it after holding through a real fall.
That's not a recommendation for anyone else's split. Build and run an ETF portfolio, lesson 1.3, Set your split from horizon, need and nerve, shows how nerve sits alongside your horizon and your need for growth. A lower share allocation may also mean lower expected long-term returns, which is a real cost. The point is to make the choice with your crash self in the room.
Knowing your crash tolerance is half the job. The other half is deciding in advance what you'll do when a fall arrives. Writing rules for falls and booms is covered in Build and run an ETF portfolio, lesson 8.2, Rules for when markets fall and when they boom, and lesson 8.1 of this course shows how to phrase them as if-then plans you can follow under stress.
Work out what a fall of one third would do to your own portfolio in dollars. Then think honestly about how you'd react, and let what you actually did in past falls count for more than what you hope you'd do.
Write the dollar loss on your portfolio in a fall of one third and how you think you would react.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).