Your allocation does more work than your fund choice

You will be able to explain why the split between asset types matters more than which ETF you use for each part.

Most people starting to invest spend their time on the wrong question. They compare world equity ETFs that are nearly identical, weigh up tiny differences in fees, and read forum threads about which one is better. Many then invest whatever cash is left over, without first deciding how much of their money should be in shares at all. The fund you pick does matter, but the split between shares, bonds and cash matters far more.

That split is your asset allocation: the share of your portfolio held in each broad type of asset, such as shares, bonds and cash. It is usually written as two numbers, shares first and bonds second. An 80/20 allocation (an illustrative example) could be 80% in a world equity ETF and 20% in a bond ETF. A 40/60 allocation is 40% in shares and 60% in bonds. If you change the allocation, you have a different portfolio, even if the funds you use stay exactly the same.

To see how big the difference is, take a bad year in which shares fall 30% and bonds stay flat (made-up figures). The 80/20 portfolio falls about 24%, which is 0.8 x 30%. The 40/60 portfolio falls about 12%, which is 0.4 x 30%. Starting from S$100,000, the 80/20 investor sees S$76,000 on screen at the end of the year and the 40/60 investor sees S$88,000. In the same year, two ETFs tracking the same index with slightly different fees would differ by only a fraction of one percent. Choosing between similar ETFs is still worth doing, but next to the allocation decision it is a rounding error.

The same logic applies in good years. Over long periods, a portfolio with more in shares usually grows faster, because shares have historically earned more than bonds over long periods in exchange for deeper falls along the way. You cannot have one without the other. More shares buys you more expected growth with bigger drops, and fewer shares buys you a smoother ride with less growth. Your job is to pick the point on that trade-off that you can actually live with.

This is where most plans break. On paper, almost everyone says they can handle a 30% fall. In practice, many people sell near the bottom, and selling after a fall turns a temporary loss on paper into a permanent one. An allocation that is slightly too cautious and held through a crash usually leaves you better off than an aggressive one abandoned halfway. The right allocation for you is the one with the highest return you will stick with, which is often lower than the highest expected return on offer.

Three factors decide that allocation: time, need and nerve. Time is how long until you need the money. Money you need in three years cannot recover from a deep fall, while money you will leave untouched for twenty years can. Need is how much growth your goals require, which you work out from your savings rate and your target. Nerve is how you behaved, or how you think you would behave, when markets fell hard. Lesson 1.3 takes you through all three and turns them into an allocation number.

Once your allocation is fixed, say 70% shares and 30% bonds (an illustrative target), every later decision in the course has a clear job. Choosing an index tells you what kind of shares fill the share portion. Comparing ETFs tells you which fund delivers that index at the lowest all-in cost. Rebalancing keeps your split near 70/30 as markets move. The investment policy statement you write at the end of the course records the whole plan, so that future you follows it rather than the headlines, whether in a panic or a boom.

If you bought your first ETF without thinking about allocation, you are in common company and nothing is lost. Most portfolios start as one fund bought on someone's recommendation. The course turns that starting point into a deliberate structure you can run for decades with a few hours of work a year.

Your task: write down what you hold today across every account, including CPF investments and SRS, and work out your current split between shares, bonds and cash as percentages. Then write the split you would choose if you were starting from zero today, and one sentence on why the two differ.

Add up your current split between shares, bonds and cash across all your accounts. Then write down the split you would pick if you were starting from scratch, and why the two are different.

Course

• Build and run an ETF portfolio