You will be able to explain how market moves change your allocation and why that raises your risk.
Farhan set his target in lesson 1.4, Draft your target allocation: 65% shares and 35% bonds. He has not touched the portfolio since, apart from his monthly purchases. When he finally adds up what he holds, he finds the share part sitting well above 65%. He did not decide that. The market did it for him, one month at a time.
Every portfolio with more than one asset does this. This lesson explains why it happens, why it quietly raises your risk, and why the fix feels wrong when you need it most.
Your allocation is a set of percentages, and percentages change when the parts grow at different speeds. If shares rise and bonds stay flat, shares become a larger share of the total even though you bought nothing, and a fall in shares shrinks their share in the same way.
Made-up example: you start with S$100,000 at 70/30, so S$70,000 in shares and S$30,000 in bonds. Shares rise 40% over a couple of good years and bonds stay flat. Your shares are now worth S$98,000, your bonds still S$30,000, and the total is S$128,000. Shares make up S$98,000 out of S$128,000, about 76.6%. Your 70/30 portfolio has become roughly 77/23.
Nothing about that looks alarming. The total went up by S$28,000, and every number on the screen is bigger than it was. That is exactly why drift is easy to ignore.
In module 1 you chose a split from your horizon, need and nerve, and you checked the dollar loss in a bad year. After drift, that check no longer holds, because you are now running a more aggressive portfolio than the one you tested.
Continue the example. Suppose shares now fall 30%. At 77/23, your S$98,000 in shares loses S$29,400, a fall of about 23% on the S$128,000 total. Had you been back at 70/30 before the fall, with S$89,600 in shares and S$38,400 in bonds, the loss would have been S$26,880, or 21%, the size of fall you planned for at 70/30.
Two percentage points of extra fall may not sound like much. But drift does not stop at 77/23. After a long run in shares, a portfolio left alone can end up far from where it started, and the bad year arrives with a portfolio you never chose. Farhan's case is starker: his share part started high and has climbed further, and his tested loss of S$11,700 no longer matches what he would actually lose.
There is no alert when your allocation moves. Your broker shows the value of each holding, but rarely what share of the total each one makes up, and almost never how far that is from a target you set months ago. Unless you check, you will not know.
Most investors who have no rule find out about drift in the worst possible way: during the next fall, when they see a bigger loss than they expected and wonder why. That is also the moment when they are most likely to make a decision they later regret. A rule written in calm conditions, which lessons 6.2 and 6.3 help you write, means drift gets caught on a date you chose, while you are calm.
The fix for drift is rebalancing: selling some of what has grown above its target and buying what has fallen below it, so that your percentages return to the split you chose. With new money, you can often do it without selling at all, which lesson 6.3, Rebalance cheaply with new contributions, covers.
Notice what rebalancing asks of you. After a run in shares, it says sell some shares, the thing that has been doing well, and buy bonds, the thing that has been doing nothing. After a crash, it says sell some bonds, the thing that held up, and buy shares, the thing everyone is afraid of. Each time, the instruction runs against what the news, your friends and your own instincts are telling you.
That discomfort is the reason a rule matters. Rebalancing makes no forecast about whether shares will fall after rising or recover after falling. It keeps the portfolio at the level of risk you decided you could live with. When it feels wrong, it is usually doing its job.
To work out your own drift, you need three numbers per asset type: what you hold today, what it adds up to, and your target. The difference between the actual percentage and the target, in percentage points, is the figure your rule will act on. Farhan's comes out uncomfortably large, and yours may surprise you too.
Using your current holdings, calculate how far your actual allocation sits from your target in percentage points.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).