You will run your rebalancing rule through a made-up crash and recovery to see what it asks you to do.
Farhan's rule from lesson 6.2, Calendar or threshold rebalancing, reads well on paper: check in January and July, and rebalance to 65/35 if shares go above 70% or below 60%. He has never followed it in a real fall. Nobody knows how they will behave in a crash until they are in one, but you can get much closer by walking through one on paper first.
This exercise runs your rule through a made-up crash and recovery, step by step, and records what it asks you to do. It takes about 25 minutes, and the figures below show the method with Farhan's rule.
Use a made-up portfolio of S$100,000 at your target split, so the arithmetic is easy to follow. For Farhan, that is S$65,000 in shares and S$35,000 in bonds. Leave out new contributions for this test, so you see what the rule does on its own.
Use these made-up returns. Shares fall 35% over the first year: 20% in the first six months, then a further 18.75% in the next six, which together take them to 65% of where they started. Shares then recover to their starting level over two years, rising about 11.4% every six months. Bonds stay flat throughout. Real crashes are messier, but this shape has the parts that matter: a fall, a second leg down when you thought it was over, and a slow climb back.
At each check date, update the values, work out the share percentage and see whether your rule triggers. If it does, trade back to target and record the trade. If you use a calendar rule, you trade at every date. If you use a threshold rule, check at whatever frequency you will actually use.
Here is how Farhan's rule plays out, with values rounded to the nearest dollar:
July, year one: shares are down 20%, worth S$52,000, with bonds at S$35,000. Shares are 59.8% of S$87,000, just below his 60% band. The rule says rebalance: he sells S$4,550 of bonds and buys S$4,550 of shares, back to 65/35. January, year two: shares have fallen another 18.75%, to S$45,947, with bonds at S$30,450. The total is S$76,397, the lowest point of the test. Shares are 60.1%, inside the band, so the rule says do nothing. July, year two: recovery starts. Shares are S$51,171, at 62.7%. No trade. January, year three: shares are S$56,990, at 65.2%. No trade. July, year three: shares are S$63,470, at 67.6%. No trade. January, year four: shares are back to their starting level, worth S$70,687, at 69.9%. Just inside the band, so no trade.
He ends with S$101,137. A portfolio that never rebalanced would end at exactly S$100,000, because shares finish where they started. The S$1,137 difference comes from the S$4,550 of shares bought near the start of the fall. Treat it as one made-up path that promises nothing about real markets. Rebalancing is a way to hold your chosen risk. It can lose money compared with doing nothing, for example when a fall keeps going for years.
Now read down your record and ask where following the rule would feel worst.
For Farhan, it is July of year one. His shares have just lost S$13,000. The news is grim, and he has no idea the fall is only half over. His rule asks him to take money out of the one part of his portfolio that held steady and put it into the part that is collapsing. Six months later, the S$4,550 he moved has fallen by almost a fifth. That is the moment he would most want to break the rule, or to decide that next time he will not follow it.
January of year two is hard in a different way. His portfolio is down about 24% from S$100,000, the lowest point, and the rule says do nothing. Doing nothing at the bottom feels just as unnatural as buying, because every instinct says to act, and the obvious act is to sell.
Your own hardest moment depends on your rule. A calendar rule may ask you to buy shares at more than one bad moment. A narrow band may trigger more trades in the fall. Find yours and mark it.
At that hardest moment, what words would keep you following the rule? Write them now, in your own voice, while you are calm. Keep them short enough to read in ten seconds.
Farhan writes: "I chose 65/35 knowing a fall like this would come. The rule is how I keep the risk I chose, and selling now would turn a loss on paper into a real one."
Avoid writing anything that predicts the market, such as "it always recovers". Your note should rest on your plan, which you control, rather than on a forecast, which you do not. Read it once more and ask whether the version of you on the worst day of a real crash would find it convincing. If not, rewrite it until that person would.
Complete the crash test sheet for your rule and write the two-sentence note you will read before rebalancing in a real fall.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).