You will be able to explain why long-term money usually needs to be invested rather than held in cash.
Darren, from the earlier lessons, will finish his emergency fund in a couple of years. After that, his S$500 a month is free for something else, and his first instinct is to keep saving it in the bank. Cash feels safe. The balance never goes down, and he has watched friends lose money on shares they bought because a colleague talked about them at lunch.
For money he needs soon, his instinct is right. For money he will not touch for twenty or thirty years, cash carries a risk of its own, one that is easy to miss because it never shows up on a statement. This lesson explains that risk, what investing asks of you in exchange for avoiding it, and which of your money it suits.
Prices rise over time. A plate of chicken rice, a bus fare and a month's rent all cost more than they did ten years ago, and they will cost more again in ten years' time. This general rise in prices is inflation, and it means a dollar buys a little less each year.
Money in a savings account earns some interest. Over long periods, that interest has often failed to keep up with rising prices, so the balance grows while what it can buy shrinks. You can check recent inflation figures from the Department of Statistics or MAS, and the rate your own account pays on the bank's website.
Here is the effect with a made-up rate. Say prices rise by 3% a year. A handy shortcut, the rule of 72, says that prices double in about 72 divided by 3, which is 24 years. Check it the long way and 1.03 multiplied by itself 24 times comes to about 2.03, so the shortcut holds. If Darren kept S$10,000 in cash earning nothing for those 24 years, it would buy what about S$4,900 buys today.
Over two years that loss hardly matters. Over the length of a working life it decides whether your savings keep their value.
Investing means buying something that is expected to grow faster than prices over time: part ownership of companies through shares, loans to governments and companies through bonds, or funds that hold many of these. The higher expected return is the payment you receive for accepting that the value will go up and down along the way, sometimes sharply.
Those falls are the price of the return, and they can be large. Imagine, with figures made up for the example, an investment worth S$20,000 that falls 30% in a bad year. It is now worth S$14,000. To get back to S$20,000 it has to rise by S$6,000, and S$6,000 is about 43% of S$14,000. A fall takes a bigger percentage rise to undo, and recovery can take years.
If you can wait, a fall like that is something you sit through. If you need the money next year, it becomes a real loss, because you have to sell at the low price. That is why the earlier layers come first. An emergency fund and insurance mean a bad month in your life does not force a sale in a bad month for markets.
So the useful question for any pot of money is when you will need it.
Money for the next few years, such as a wedding, a down payment or your emergency fund, belongs in places that do not fall in value, even though they grow slowly. A good investment can still be down at the moment you need to spend.
Money you will not need for many years, such as retirement savings or a fund for a child who is a baby today, can afford to ride out the falls. It is also the money that inflation would eat most if it sat in cash.
Wei Ling, from lesson 5.2, sorted her goals by what pays for them. Sort them again by time and the picture changes. Her wedding in two years and her flat in three are short-term and stay in cash and CPF. Her retirement, more than thirty years away, is the goal where investing fits.
No investment removes risk. Two things reduce it.
The first is diversification: spreading your money across many investments so that no single failure can do much damage. If you put everything into one company and it collapses, you can lose the lot. A fund holding hundreds of companies across several countries can still fall, sometimes a long way, but it is very unlikely to go to zero, because a few failures are outweighed by the rest.
The second is time. Over a single year, the value of a spread of investments can swing widely in either direction. Over twenty years, the good years have more chance to outweigh the bad ones, and any one bad year matters less to where you end up. Time improves the odds without guaranteeing anything, which is why money you might need early should not be relying on it.
Neither of these tells you what to buy, and this course will not. Lesson 6.3 covers the accounts you can hold investments in, and the investing track covers how to choose.
Before then, go back to your own goals from lesson 5.2 and look at each one with a single question in mind: how many years until you need this money?
Write down which of your goals are more than ten years away and how much you have set aside for each today.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).