You will be able to turn your time horizon, the growth you need and how much of a fall you can take into a target allocation.
Once you've decided to invest, you still need to split your long-term money between shares and lower-risk assets. A common rule of thumb, often heard at CPF talks, is to hold 100 or 110 minus your age in shares. The age rule is quick to use, but it leaves out when you need the money, how much growth your goal requires, and how you behaved during past market falls.
A better method is to answer three questions, about horizon, need and nerve. Each one gives you a range for the share part of your allocation. You then take the lowest of the three, since that answer is usually the one that protects you from your own worst decisions.
Your horizon is when you need the money. A horizon belongs to a particular pot of money, so one person can have several. A 30-year-old saving for a wedding next year and for retirement will get two different answers, one for each goal. Lesson 1.4 separates multiple horizons properly. Until then, look at each goal on its own.
Money you'll need within about five years belongs mostly in lower-risk assets such as deposits, T-bills and high-quality bonds. A deep fall in shares can take longer than five years to recover, and you don't want to be forced to sell at the bottom because a renovation contractor is waiting to be paid. Money with a five-to-ten-year horizon can take some share risk, often up to about half, because there is time for a partial recovery. Money you won't touch for more than ten years, such as retirement savings in your thirties, can hold as many shares as the other two questions allow.
The course uses these bands as starting points. If you have a reason, you can move them.
Farhan, whom you met in lesson 1.2, has S$60,000 of long-term money (an invented example). He is saving it for retirement, so his horizon allows up to 100% shares.
Your need is the yearly return it takes to get from where you are now to your goal. You find it with the spreadsheet RATE function, which you first used in How money works, lesson 3.4, "Calculate the EIR of a flat rate offer with the RATE function". The pattern is =RATE(years, -annual contribution, -current amount, target).
Farhan adds S$12,000 a year and wants S$500,000 in 20 years. He enters =RATE(20, -12000, -60000, 500000) and gets about 4.2% a year. His own money adds up to S$300,000, made of the S$60,000 he starts with plus S$12,000 a year for 20 years. Growth has to supply the rest of the S$500,000.
Next, compare your required return with what lower-risk options pay today. Current T-bill and Singapore Government Securities yields are on the MAS website. If your required return is at or below those yields, your goal needs little share risk, and taking on more would be a gamble you don't need. If it is well above them, you need a meaningful share allocation to have a reasonable chance of getting there. When Farhan checked, his 4.2% was above safe-asset yields, so need puts him at 60 to 80% in shares.
Need rarely produces an exact figure. It stops you from taking more risk than your goal calls for, and it tells you when a goal can't be reached at any sensible level of risk. In that case, raise your savings rate or push back the target date.
Your nerve is what you did, or would do, when markets fall, and it reflects how much loss you can really tolerate. Most plans fail on this question, so answer it honestly.
Your own history is the best evidence you have. If you sold, paused your monthly investing, or avoided opening the app during a past fall, write that down, since what you actually did tells you more than any risk questionnaire. The last time markets fell hard, Farhan stopped buying for six months, and he notes this.
If you haven't been through a big fall with real money, think in dollars instead of percentages. Plenty of people who say they could handle a 30% fall have never pictured what 30% of their own balance would be. Decide the largest dollar drop you could watch without selling, and work back from it to a share percentage.
To do that, assume shares fall 30% and work out what you would lose if all your long-term money were in shares. For Farhan, 30% of S$60,000 is S$18,000, which means every 10% he holds in shares costs him S$1,800 in that bad year. He decides the most he could sit through is a S$12,000 loss. S$12,000 divided by S$18,000 is about 67%, so his nerve answer is roughly 65% in shares or less.
Farhan now has three answers:
Horizon: up to 100% in shares, as this is retirement money Need: 60 to 80% in shares Nerve: about 65% in shares
Nerve gives the lowest figure, so he sets his target for the share part at about 65%.
The lowest answer usually wins because being too aggressive costs far more than being a little cautious. Go above your nerve and you are likely to sell in the next crash and lock in the loss, the failure described in lesson 1.1. Fall short of your need and you can save more, work a little longer, or adjust the goal, which is uncomfortable but recoverable.
You shouldn't simply settle for the low figure when your nerve answer sits far below your need. In that situation, work on both sides: raise your savings rate so the goal needs less growth, and use the rules in module 8 to make market falls easier to sit through.
Now it is your turn. Answer the horizon, need and nerve questions for your own money, note the share range each one gives you, and take the lowest as your target share allocation. Be strict with the nerve question in particular, because lesson 1.4 turns whichever answer comes out lowest into a target you will be held to.
Use the course worksheet to score yourself on horizon, need and nerve, and write down the allocation each score points to.
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