What Should be Included in Your Retirement Financial Plan 

October: This is one of the peculiarly dangerous months to speculate in stocks in. The other are July, January, September, April, November, May, March, June, December, August, and February.--Pudd'nhead Wilson's Calendar, by Mark Twain

Stocks often post their best returns in the fourth quarter, but so far this quarter, the first month has not been kind to investors. In fact, it’s been scary with triple-digit price swings from one day to the next.

The bond market also hasn’t been cooperating; municipal bonds suffered their sharpest loss in 18 months last Wednesday. The U.S. economy is on life-support. Job creation barely has a pulse. Nationally, the average home is worth what it was back in May 2003, after losing more than a third of the value it had at the peak of the real estate bubble.(1) Euro zone debt worries have skewered the euro and pushed the region to the brink of another recession. There are also  rumblings of double-digit inflation worries brewing in China’s behemoth economy.

So what else is new?

As Pudd’nhead Wilson points out, risk is inherent in investing, regardless what the time of year.

But a bigger risk is running for the exit--especially now. Selling low and buying high (why do you think the price of gold has gone stratospheric?) is not the way to run a long-term investment strategy. “Long-term” is how most investors ought to be thinking. Even if you’re close to or already in retirement, your portfolio should be positioned in terms of decades instead of day-to-day. But when it comes to thinking about our investments, we aren't doing it in a rational manner.

“Following your emotions feels good,” admits Erik Davidson, deputy chief investment officer for Wells FargoPrivate Bank, “but it doesn’t work.” While they might leave you feeling sick, you might as well get used to big swings in market prices, they're here to stay for awhile. Our country's soaring budget deficit, 9% unemployment rate and other economic problems will not be solved overnight. Not to mention the heated presidential election that is around the corner: the finger pointing, rhetoric and headlines are only going to intensify. Since markets are really made up of investors--who are human and, therefore, emotional--it’s likely that volatility will increase over the next 12 months.

It’s also going to take time (and pain) to resolve the debt issues rocking Europe, according to Davidson. “The European situation will go on for a long, long time,” he predicts. “It took [the United States] more than a century to achieve monetary union. The euro is only eight years old, it’s going to be a long, bumpy road.”

Davidson is not insensitive to how market volatility is affecting investors. He points out that, unless you lived through the Great Depression, “what we’ve been through in the past four years is the worst market and economic environment” most Americans have experienced.  In fact, this week will mark the anniversary of the all-time high set by the S&P 500 on Oct. 11, 2007 it hit an intraday high of 1576.  We’re still 27% off that mark. But perspective is crucial. “We were off 57%,” says Davidson. “At one point [in the past four years] the S&P got as low as the mid-600s.”

Unfortunately, it’s tough to maintain perspective when your 401(k) account is still worth less than it was four years ago.  And, thanks to something called the “recency effect,” humans tend to assume that what happened yesterday is also what is going to happen tomorrow.  As a result, says Davidson, we’re afraid that the problems and market reactions we saw in 2008 will happen again.

The result is predictable: two of the most popular methods of dealing with recent market upheaval have been fleeing to cash or gold.  Both might have made sense if you’d had the prescience to do so before the markets cratered in 2008. If not, it’s a bit like closing the proverbial barn door after the cow has escaped- it’s too late.  Moreover, both are potentially risky to your financial health over the long term.  If you think you’re “safe” keeping your money in short-term instruments earning a half percent or less, consider this, says Davidson: “You’re on a path to double your money in 1,440 years. I don’t think the average person has that long a timeframe.”

Even if you go out further on the yield curve and buy 10-year Treasury notes, you’re still only getting a return of about 1.25%.  When you consider that you have to pay income tax on what you earn, and that over the past 12 months inflation has aged 3%, your after-tax, inflation-adjusted return is a negative 2%. “Effectively, investors are so scared they’re choosing to lose money safely.”

You’re also too late to the game if you’re stuffing your portfolio with gold.  “If it looks, walks, and talks like a bubble” it is one, according to Davidson.  “It pays no interest, no dividend. You’ve got to pay to store it and protect it with insurance. Have some, sure.  But people are putting ridiculous amounts into gold.”  He says some investors “want to invest 20, 30, 40% [of their portfolios] in gold.”

The last time the price of gold was in bubble territory was back in 1980, when the price soared to nearly $700 an ounce. According to Davidson, investors who invested at gold's peak back then didn't break even until January 2008 in nominal terms; meaning they made back their original investment in terms of dollars, but are still behind on an inflation-adjusted basis.

As difficult as it is to watch the value of your investments fluctuate, (sometimes significantly), as the late Sir John Templeton said, “The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”  Templeton, who pioneered the concept of investing outside one’s home market and who made a fortune for himself and others by doing so, would be having a field day in a market such as this.

The trouble is, few of us have Templeton’s experience and discipline: “Buy low, sell high” makes intellectual sense, investing your money in something that has declined in value and, by definition, most everyone else is selling, makes your stomach churn. It’s uncomfortable to head in the opposite direction as the herd.

That’s why it’s critical to have a plan. Davidson likens volatility in the financial markets to running into rough air when flying. “When you get on a plane, you’re prepared for turbulence. That’s why they have the safety demonstration--so you know what to do. The worst thing would be to unbuckle your seatbelt, run for the exit door and jump out.”  Yet most Americans do not have a written plan for the most important goal of their financial lives: retirement. “When you have a plan, you have a road map,” says Davidson.

Your financial plan should spell out how your portfolio will be invested, how frequently it will be re-balanced, the expected return, how much you can withdraw, and the expect level of risk, or total fluctuation in value.  It should also outline various “what-if scenarios" so that you know in advance what steps to take. This leads to confidence; instead of panicking and reacting to each market swing, you refer back to your plan and avoid a knee-jerk reaction.

“To the extent your financial goals are measured in weeks or months, your financial strategy should be tailored to that,” says Davidson. For instance, the money he and his wife need to pay for their daughter’s upcoming wedding is parked in short-term investments that offer little return, but low fluctuation. But for longer-term goals that are measured in decades, like saving for a young child’s college education, a second home and retirement, those “need a strategy calibrated to that,” he says.

Of course, you’ve heard and read this advice before, but it continues to get repeated because so far, no one has come up with a better approach. A regularly-balanced, diversified portfolio- including overseas stocks and bonds- has, over time, provided the best return and fewer "Maalox moments."

Despite the fact that the first 10 years of the 21st century have been dubbed “The Lost Decade” of investing, Davidson maintains that if you’d owned "the proper mix of U.S. stocks, foreign bonds, REITs (real estate investment trusts), commodities, and hedge funds, you were up 45%.”

As a wise friend used to say, when you try to time the financial market, you’ve got to be right twice. That is, you not only have to know when to get out, you also have to know when to get back in.  In Davidson’s words, “The risk is when people unbuckle their seatbelts and start jumping out, they miss a huge rally.”

I leave you with two quotes from Sir John Templeton:

“People are always asking me where is the outlook good, but that’s the wrong question…. The right question is: Where is the outlook the most miserable?”

“Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.”

Now you know the recipe for buying low and selling high.

1. S&P/Cash-Shilller 20-city composite index.

2. Interest rate on 6-month T bill as of 10/8/11 was 04%.

Ms. Buckner is a Retirement and Financial Planning Specialist and an instructor in Franklin Templeton Investments' global Academy. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content. 

If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com, along with your name and phone number.