The Retirement Corporation of America

The Rules For Riding Out Turbulent Times

NO MATTER HOW bright the economic outlook or how bullish the stock market, the one thing you can be certain of is that things are going to change. The economy never stands still. It is always in motion—always moving from boom to bust and back again.

•  The booms are called expansions. That means that the economy is growing—as it has done most of the time since they began keeping economic records around 150 years ago. Once the economy starts rolling, it tends to keep rolling. The average expansion since the end of World War II has lasted three-and-a-half years.

•  The busts are called recessions. That means the economy stopped growing for at least six months. Counting the one that began in March 2001, we've had 32 recessions since the first recorded one began in June 1857. They don't last long, as a rule. The average recession since 1857 has lasted 19 months. The average recession since the end of World War II has lasted less than a year.

•  The combination of expansion and contraction is called the business cycle. It represents one complete turn of the economic wheel—from the peak of the expansion past the bottom of the contraction, back to the peak of the expansion again. The average cycle—top to bottom to top again—lasts roughly five years. For the record, the Great Depression wasn't a single event, but a series of events: a recession that ran from August 1929 to March 1933; then a recovery that lasted until May 1937; then another recession that lasted until June 1938; then a recovery that lasted until February 1945.

How to Plan Ahead for Tough Times

Since recessions and bear markets are inevitable, the secret to keeping cool when the world turns turbulent is to be proactive, rather than reactive.

In other words, anticipate turbulence by planning ahead rather than reacting to turbulence after it has arrived. If you find yourself in financial trouble when times do turn turbulent, it means you did no advance planning or the planning you did was inadequate.

You can't make your plans on the assumption that hard times will never hit—because they will. What you can do—what you must do—is make all financial plans based on the assumption that they will have to stand up to turbulent times when they arrive. Here are The 10 Planning Rules you must consider if you want to be able to stay on your feet when times do turn turbulent:

Rule #1: Plan for what is possible. You obviously want to earn as high a return on your investing as is humanly possible—30% a year, 50% a year, or 100% a year. After all, some of the hottest technology stocks of recent years delivered returns of 200% and 300% a year—and more.

If you could only increase your money by 300% a year, you'd quickly be a millionaire, and all of your financial worries would be behind you. Yes, you could earn 300% in a year—with the right stock. But what about the bear market of 1973-74, when the Standard & Poor's 500 lost 50% in 21 months—or the Market Crash of 1929, when the Dow Jones industrial average plunged 89% in less than three years? Or the bear market of 2001-02 when those technology stocks stopped posting gains and began posting horrendous losses?

Hope for the best—but know that sometimes it won't happen. Long term, over 70-plus years, stocks have returned about 11% a year. With your skills, expect to earn about 15% a year on your investments over the long term. Shoot for less, and you are being too conservative. Expect a lot more and you could be very disappointed. Hope for a little better-than-average return over time, and the odds are you will achieve it.

Rule #2: Plan to keep your investment strategy simple. Put away at least 10% of your pretax annual income into investments each and every year come what may. Invest at least half that money in stocks, even if you're approaching retirement. Keep the number of investments—stocks, mutual funds, bonds—to a number you can readily manage. There are more than 7,000 mutual funds. You don't have to own more than a half-dozen to be as diversified as you need to be.

Rule #3: Plan for risks you can live with. There will always be hot stocks and hot mutual funds. Every cocktail party or office coffee break will bring stories of this person or that who bought just the right fund and got rich. Hot stocks and hot funds cool quickly, though, and today's riches can become tomorrow's tales of woe. Stick to risks you are comfortable with, and don't chase after dreams. Gamble on some high-flyer, and the first time you lose more than you feel you can afford to, you'll go scurrying for the safety of money market funds, certificates of deposit or savings accounts. Having been once burned, you very likely will be twice shy—meaning you'll overemphasize safety and forever doom your nest egg to mediocrity.

Rule #4: Plan to invest within your own level of expertise.
Even a relatively new investor should have no trouble understanding what a large-cap growth mutual fund is all about. Whatever you don't know, you can easily learn by calling the fund's toll-free number or going to its website. On the other hand, selling a call option on those shares of your company's stock that you own requires much more experience. And trying to calculate the potential for gain on a futures contract in soybean futures requires the skills and experience that only a market professional would be likely to have. Stick with what you know, and you'll be a whole lot safer and comfortable. You can expand your investment horizons as you gain experience. Just know what your limits are and don't go beyond them, if you want to stay cool when times get tough.

Rule #5: Plan with your own limits firmly in mind. You want to invest for maximum return, in order to make your financial dreams come true. You will also want to hold some bonds for income, and some cash to meet current needs and to use when investment bargains present themselves. When the markets are rallying, it's human nature to want to put everything into stocks—and the flashier the better. Pick an asset mix that suits your comfort level and stick with it through thick and thin. There will be times when you want to make changes in your investments. The economy may dictate adding to some, or subtracting others, or your financial goals may change. Keep the overall risk of your portfolio the same—one you can live with—even when you do make changes.

Rule #6: Plan to allocate your assets wisely. Don't put all your eggs in one basket. Don't buy only stocks or only bonds. Don't hold your money only in cash. Stocks will suffer when the markets turn bearish—but they will outperform bonds and cash when the bulls are in command. Bonds will hold up better when the economy is slumping, but they don't offer any protection against inflation. Cash offers a lot of safety—but it doesn't offer any potential for gain, and it doesn't offer any protection against inflation. Prepare for both good times and bad by allocating your assets among stocks and bonds and cash—instead of betting everything on just one asset class.

Rule #7: Diversify—within reason. You don't want to scatter your nest egg over so many different investments that you can't keep track of them. Neither do you want to gamble everything on one or two stocks or just one mutual fund. Don't overdo diversification—but don't ignore it, either. Own some big-company stocks or funds, some small-company stocks or funds and a fund that invests in foreign stocks. Buy a fund that invests in good quality corporate bonds for decent income (those rated "A" or better by Moody's or Standard & Poor's). If you're in a high tax bracket, consider municipal bond funds, even though they typically carry lower yields than corporate bonds. Interest on municipal bonds is exempt from federal income taxes and sometimes from state and local taxes.

Rule #8: Don't jump on the latest investment fad. In the days of the Internet bubble, dot-com companies were all the rage, even if few had any track record to speak of. A few were winners, but most proved to be big losers. Don't waste effort—and maybe your money—trying to pick the next hot stock of any kind. The same goes for trying to pick the next superstar mutual fund manager. You have long-term goals that you are working to achieve. You won't reach those goals if you chase after every fad that comes along.

Rule #9: Don't fall in love with your investments. You have high hopes for a stock or fund—or else why did you buy it? Nevertheless, times change and circumstances change. Once-successful companies lose their way and become also-rans. New technologies appear that capture markets from businesses that once appeared impregnable. You want to invest for the long term, because investing for the long term is the surest way to prosper in our growing economy. When you sell, you don't want to do it on a whim—because the stock had a bad month, or Mary at work heard a rumor. Sell only after you have examined the investment, decided its long-term prospects really had turned dark, and concluded your money would be better invested elsewhere. Don't be afraid to sell if that's what your investment wisdom tells you is the right thing to do.

Rule #10: Don't panic—come what may. This is the last—and the most important rule of all. If you act in haste and panic, you are almost certain to do the wrong thing. There's an adage on Wall Street that the small investor is always wrong—and the key to success lies in watching what small investors are doing and then do the opposite. Novice investors do tend to buy when prices are the highest and sell when the market reaches bottom. Don't buy because prices are up—or sell because prices are down. Don't buy because everyone else is doing so—or sell because the market is having a sinking spell. Invest with intelligence and with a specific asset allocation in mind. Stick with that allocation and sell only when common sense tells you to do so—not because times have turned turbulent and you are in a panic about your financial future.