You will be able to write a target allocation for your long-term portfolio, with a dollar figure for the worst year you are planning for.
Having three answers on horizon, need and nerve, plus money spread across several accounts, does not give you a plan yet. A plan states which money it covers, how that money is divided between shares and bonds, and roughly how many dollars you would see lost on paper in a bad year. You can write the whole plan as one line in about 25 minutes by working through four steps in order.
Farhan already has his three answers from Lesson 1.3, "Set your split from horizon, need and nerve". His horizon allows almost anything for his retirement money. His need points to 60 to 80% shares (an example figure), and his nerve says about 65%. He holds a world equity ETF worth S$52,000 and a savings account with S$20,000, and he keeps a CPF statement in a drawer.
List every pot of money you have and give each one the year you expect to spend it. Money you are keeping for the long run with no planned use gets "none". Any pot due to be spent within about five years comes out of the long-term portfolio now. Your emergency fund comes out too, because you might need it as soon as next month.
Keep dated money and the emergency fund in deposits, T-bills or high-quality bonds matched to the date. The course "Bonds, T-bills, SSBs and fixed deposits" explains how to hold them. Neither the dated money nor the emergency fund is part of your share/bond split, because each has a different job from the money you are investing for the long run.
Leave your CPF savings out for now as well. CPF earns CPF interest and follows its own rules. Module 7 brings CPF and SRS into one view with the rest of your money.
What remains is your long-term money: money with no spending date, or none within about five years, excluding the emergency fund. The split you choose in the next step applies only to this money.
Farhan divides his S$20,000 of savings into a S$12,000 emergency fund, which he keeps in cash, and S$8,000 with no decided use. He has no other goal before retirement. His long-term money is the ETF plus the undecided savings, which comes to S$52,000 + S$8,000 = S$60,000.
Take the lowest of your three answers from Lesson 1.3 and round it to a share/bond split. Round splits such as 60/40 or 70/30 are easier to remember and easier to rebalance towards. If your lowest answer is a range, use the bottom of the range unless you have written down a reason to go higher.
Then convert the split into two dollar targets, one for shares and one for bonds, both calculated on your long-term money.
Nerve is Farhan's lowest answer, so he chooses 65% shares and 35% bonds. On S$60,000, his targets are S$39,000 in shares and S$21,000 in bonds. He currently holds S$52,000 in shares and S$8,000 in cash, which puts him well above his share target.
If you hold more in shares than your target, you do not need to sell straight away. Reaching the target with new money first costs less, and Module 6 shows how to do it. Farhan sells nothing for now and leaves his S$52,000 in the ETF where it is.
Many people skip this step, but it is the step that tests whether you could hold your split when prices fall.
For this calculation, a bad year is an invented year in which shares fall 30% and bonds stay flat. The loss you would see on paper is worked out like this:
Bad-year loss = long-term money x share percentage x 30%
For Farhan, that is S$60,000 x 65% x 30% = S$11,700. At the low point his portfolio would be worth about S$48,300, with the whole portfolio down 19.5%. He has said he could watch a loss of up to S$12,000 without selling, so S$11,700 is just under his limit.
Lesson 1.2, "What shares, bonds and cash each do in a portfolio", warned that bonds can fall in the same year as shares. Do the calculation again with bonds falling too. Farhan tries bonds down 5%, which adds a further loss of S$1,050 and brings his total loss to S$12,750, a little over his limit.
When the stressed loss goes over your limit, you can either lower the share percentage or accept a worst case above your limit. Farhan works out that at 60/40 the same stressed loss is S$12,000. He compares that with staying at 65/35 and accepting a worst case slightly above his limit. He decides to stay at 65/35 and writes S$12,750 next to it, so he has already seen the bigger number before a bad year in the markets produces it.
If your own figure makes your stomach turn, lower the share percentage and recalculate until you reach a loss you could sit through. A cautious split you can hold is better than one you would abandon. Whatever you decide, write the stressed figure down next to your split, as Farhan did with S$12,750.
Your allocation is finished when it fits on one line you could read aloud. An allocation line is a single sentence giving the split, the money it covers and the dollar loss you expect in a bad year, with a commitment not to sell.
Farhan's line covers long-term money of S$60,000 at 65% shares and 35% bonds. It says that in a bad year with shares down 30%, he expects about S$11,700 to disappear on paper, and it commits him not to sell.
Every choice in your line should trace back to your horizon, need or nerve, and to a dollar figure you have checked twice, so that in a bad year you cannot tell yourself the split was chosen at random. The dollar figure in the line will go out of date, and updating it every year is part of your review. In Module 8 this line becomes the first entry in your investment policy statement.
Now work through the four steps with your own figures and write your line. First, list your pots with their spending years, and take out anything due within about five years, your emergency fund and your CPF. Second, choose a split from your lowest answer, round it, and set dollar targets for shares and bonds. Third, work out your bad-year loss twice, once with shares falling 30% and once with bonds falling as well, and write the stressed figure down. Last, write one sentence that gives the money covered, the split, the expected dollar loss in a bad year and your commitment not to sell.
Submit a one-page allocation draft: your target split, the dollar loss in the made-up bad year, and three sentences on why you chose it.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).