You will be able to state the job each asset type does and what it costs you to hold it.
Farhan is 32 and works in operations at a logistics firm in Tuas. Three years ago he opened a brokerage account and bought a world equity ETF, and he has added to it most months since. He also has about S$20,000 in a savings account and a CPF balance he rarely looks at. When a colleague asked him why he holds no bonds, he said bonds were for old people. Then he realised he could not say what bonds would actually do for him.
Most investors are in the same position. They know shares go up over time and that cash is safe, and the rest is fuzzy. Before you can choose a split, as lesson 1.1, Your allocation does more work than your fund choice, asked you to, you need to know what job each asset type is hired to do and what it charges you for doing it.
When you own a share, you own a slice of a company's future profits. Over long periods those profits have grown, and share prices with them, which is why shares are the growth engine of almost every long-term portfolio.
The price for that growth is the falls. They come without warning and they can be deep: a broad share market can lose a third of its value or more in a bad stretch, and you cannot tell at the start whether the recovery will take one year or many. That is the cost of holding shares. It is not the risk of the money disappearing, since a world index holds thousands of companies, but the risk of seeing a much smaller number on your screen at the moment you were hoping to use it.
So shares suit money with a long runway. They do their job only if you can hold them through the bad years without being forced, or tempted, to sell.
A bond is a loan with a fixed timetable, as the course Bonds, T-bills, SSBs and fixed deposits explains from its first lesson. In a portfolio, high-quality bonds, such as those issued by strong governments, play a different role from shares. Their prices usually move much less, so when shares drop hard the bond part of your portfolio tends to hold its value or fall far less.
That steadiness does two things for you. It makes the whole portfolio fall less, which makes it easier to stay invested. And it gives you something to sell when shares are cheap. If shares have fallen and bonds have not, your bonds have become a bigger share of the portfolio than you planned, and moving some of that money back into shares is how you rebalance. Module 6 covers the rule for doing that.
The cost is growth. Over long periods, high-quality bonds have usually earned less than shares, so every dollar you put into bonds is a dollar not in the growth engine. Notice the word high-quality, because bonds from weak borrowers can fall alongside shares in a crisis, because both depend on companies doing well.
Cash means savings accounts, fixed deposits and similar places where the balance does not fall. Its job in your plan is to cover what is coming soon: your emergency fund, next year's course fees, a renovation in eighteen months. Money you need on a known date should not depend on what markets do in the meantime.
The cost of cash is inflation. Lesson 4.2 of How money works, Real return is roughly the nominal return minus inflation, showed how a balance can grow in dollars and still buy less. With made-up figures, cash earning 0.5% while prices rise 2.5% has a real return of about minus 2% a year, and ten years of that leaves a real dent. Cash is safe in dollars and steadily unsafe in buying power, which is why it suits the near term and works badly as a home for money you will not need for twenty years.
Many people learn that bonds go up when shares go down. That happens often, but it is not a law. When interest rates rise quickly, bond prices fall. Older bonds paying lower rates are worth less to a buyer. Shares can fall in the same months, perhaps because higher rates squeeze companies, and then both parts of your portfolio drop together.
This does not mean bonds have failed at their job. High-quality bonds have still usually fallen less than shares in those years, and once rates are higher, new bonds pay more. It does mean you should not build a plan that assumes your bonds will rise every time shares fall. Plan for a bad year where your bonds only fall less, and treat any year where they rise as a bonus.
Here is the trade in one line each. Shares buy you growth and charge you deep falls. Bonds buy you a softer ride and money to rebalance with, and charge you growth. Cash buys you certainty in dollars and charges you buying power.
Farhan wrote those three lines on a sticky note. Then he wrote what he actually holds next to each one, and found that his S$20,000 in savings was doing a job he had never given it. Some of it was his emergency fund. The rest was long-term money sitting in cash because he had not decided anything. In the activity below you will do the same exercise for your own holdings.
For each asset type in your portfolio, write its job in one sentence and the risk you accept by holding it.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).