You will be able to distinguish short-term price swings from permanent loss and link both to your time horizon.
Two colleagues open their investing apps on the same bad morning. Both see the same fund down 25% from its high. One shrugs and closes the app. The other feels sick, because the money is meant for a renovation that starts in March. They hold the same thing and the price moved the same amount, but only one of them is in trouble.
This lesson is about why. Risk is often described as how much a price jumps around. That is part of it. The part that hurts you is what the price is doing on the day you need the money.
Volatility is how much a price moves up and down over time. A savings account balance barely moves. A broad share fund can rise or fall by a fifth or more within a year. A single company's share can move further still. Volatility is visible every day, which is why it gets most of the attention.
Permanent loss is different. It is money that does not come back. A company goes bust and its shares are worth nothing. A scheme collapses and the operators disappear. You sell a holding at a low price and spend the cash, so you never own it when the price recovers.
A price drop is not the same as a permanent loss. Say, as an example, Daniel puts S$20,000 into a fund that tracks a broad share market. In a bad year it falls 30%, and his holding shows S$14,000. If he keeps holding and the market later climbs back, the S$6,000 was a paper loss that came and went. Broad markets have recovered from past falls, though how long that took has varied a great deal, and nothing guarantees the next recovery will be quick. If the fund held one company that failed instead, part of that S$6,000 might never come back.
A drop matters most if you are forced to sell at that moment. That is the whole difference between the two colleagues.
Daniel's S$14,000 only turns into a real S$6,000 loss if he sells. People rarely sell at the bottom because they chose to. They sell because a bill arrived, or they lost a job and needed to cover rent, or a deposit on a flat fell due. The price on that one day decides what they walk away with.
So a useful way to think about risk is to ask: what is the chance that I will have to sell this when the price is down, and how bad would that be? For money you can leave alone through a bad patch, a fall is uncomfortable but survivable. For money with a fixed date attached, the same fall can wreck a plan.
Your time horizon is how long until you need the money. It changes how risky the same holding is for you.
Money you need within a few years carries more practical risk in a volatile asset, because there may not be time for a fall to recover before the date arrives. Take the renovation example, with figures made up. The second colleague planned S$30,000 for March. If her fund is down 25% then, she has S$22,500. Either she cuts the renovation, borrows the S$7,500 gap, or delays. None of those were in the plan.
Money you will not touch for decades is in a different position. A fall in year three can be followed by many years of recovery before you need the cash, although no one can promise it. This is why the same fund can be a reasonable place for retirement savings and a poor place for a wedding budget. The fund is the same. The calendar is not.
Price swings are the risk people notice. Three others do damage more quietly.
Concentration: too much in one company, one sector, one property or one institution. If that one thing fails, there is nothing else to soften the blow. An employee who holds a lot of shares in the company they work for can lose the job and the savings at the same time. Inflation: money held for years at a rate below inflation loses buying power steadily, as you saw in lesson 4.2, Real return is roughly the nominal return minus inflation. It never shows as a fall on screen, which is why it gets ignored. Failure of the institution holding your money: a bank, an insurer, a broker or an app. Lesson 1.3, What SDIC deposit insurance covers and what it does not, showed which deposits are protected and up to what limit. Anything outside that protection depends on the firm and on how your money is held.
The safest-looking option on the triangle from lesson 5.1, Every place you put money trades risk, return and liquidity, still carries at least one of these. Cash avoids price swings and takes on inflation risk in exchange.
The question that makes all of this personal is simple. For any pot of money, when do you need it, and what happens if it is worth less on that day? A goal with a fixed date and no room to slip deserves a different home from one that can wait. Start with your own goals and give each one a date and a rough sum, because a date is what turns a price drop from a number on a screen into a problem you can size.
For three goals you have, write when you need the money and what would happen if it were worth 20% less on that date.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).