Have a plan to help you ride the market's ups and downs

It's been more than a week, and government pooh-bahs still can't say for sure what caused the May 6 "flash crash" in the markets.

Solutions are more forthcoming, but they don't exactly inspire confidence. Circuit breakers? A ban on "stub quoting?"

It's enough to drive the average 401(k) owner to stick their fat finger on the withdrawal button.

With more ups and downs to come, what can the rest of us do to keep our amygdalas from retreating to the safety of a bank?

It's a good time whip out -- or whip up -- an investment plan.

Advisers and pension plan managers call them Investment Policy Statements or investment strategy statements. But don't let those names scare you either.

Just think of it as a written pledge, a map, reminding you why you're saving, how you'll save and under what circumstances you'll shift course.

Note: Those circumstances will not include days like May 6. Or months like May, for that matter. Short-term market gyrations are exactly when a written plan comes in handy. It's your own circuit breaker, keeping your emotions, or oversized finger, from getting the best of you.

"It's like a household budget," said John Ritchie of Great Northern Asset Management in Vancouver. "If it's in your mind, you forget about it after the second glass of wine and order a more expensive bottle."

Some money managers say you need to consult a professional when developing such statements. Schwab wants you to call its toll-free number for a "Toolkit."

But you can formulate your own plan yourself.

"I don't think there's anything we as professionals do that an individual can't do on their own," said Robert Haley, a certified financial planner and owner of Advanced Wealth Management Inc. near Portland. Of course, it takes time, learning, emotional energy and discipline. Plans are supposed to help you stay disciplined. They can help you believe, again, in what Haley says: "Last week's volatility should be irrelevant to most investors."

You might actually need several such plans, depending on your savings goal and your time getting there. Here's what to think about as you go about formulating one:

Finances: Get a grip on how much you have invested in all sources -- 401(k)s, IRAs, CDs and brokerage accounts. Figure out how much you can regularly contribute going forward.

Goals: Clarify your purpose for saving. College? Retirement? A new house? Keep your goals to a couple of words.

Time horizon: Calculate how long you have to meet these goals. "The differing time frames of the goals could lead to a different risk tolerance for each," said Doug Everett, president of the Financial Planning Association of Oregon and Southwest Washington.

Risks: Guess how much up and down can you stomach. You might not be able to, but putting something down on paper will help you choose the types and amounts of investments you'll make. It also stands to help you stick to your picks when the market tanks, taking your sensibilities with it.

Returns: Identify a rate of return you expect, given your needs and the risk you're willing to take. Be reasonable about it. For example, you might forecast stocks to return about 6 or 7 percent a year in the future; bonds might return 4 or 5 percent; cash 2 percent. Also know the inflation rate (about 3 percent historically; 2 percent currently) because you want your returns to exceed it.

Asset Allocation: This intimidating lingo simply means deciding how much money you're going to put in stocks vs. how much in bonds vs. cash. If you want, you can break those categories down even further -- international stocks vs. domestic stocks; blue-chip vs. small-cap vs. mid-cap stocks; long-term vs. short-term bonds. If you do, make sure you know the purposes, risks and reasonable returns of each.

Haley and others also suggest you pick a range for these allocations.

For instance, a 24-year-old might want a range of 85 to 95 percent of her holdings in stocks and 5 to 15 percent in bonds. A 60-year-old might want 40 to 60 percent in stocks and 40 to 60 percent bonds.

When your mix strays outside those ranges, you'll know you should shift money around to bring your holdings back within their original scope.

Picking funds: Figure out what characteristics are most important to you. Expense ratios below 1 percent? Returns that exceed peers over 5- to 10-years? Manager tenure of three years or more? Matching market returns (index funds) or trying to beat them (actively managed funds)? Review these priorities before you pick a fund.

Peeking: Write down how often you will check your returns and, more importantly, your allocation mix. Plan to do so once a year, but no more than once every three months. Pick an appropriate benchmark to use to compare your returns. The Standard & Poor's 500 index would be best for the 24-year-old invested entirely in stocks. But a retiree 60 percent in bonds will want to visit Morningstar for an account of how all Conservative Allocation Funds performed

Also, look back at your overall expected returns. Visit my blog to figure how to calculate the portfolio's average.

Rebalancing: A run up or decline in values of your stocks or bonds can leave your portfolio wobbling and, ultimately, too risky for your own good. Your previous work writing down an allocation range will guide you in deciding how much money to move from stocks back into bonds or cash, or vice versa.

More detailed help:

Morningstar offers a two-page form online at its investment classroom, Portfolio 100. It offers another version. I suggest looking at both. Bogleheads.org also has a nice, concise guide with two examples.

Marilyn Bergen,  of CMC Advisers in Portland, likes, "Winning the Loser's Game: Timeless Strategies for Successful Investing" by Charles D. Ellis. It won't tell you how to write a plan, but it contains chapters related the concept, including, "Why Policy Matters."

Let's hope that by the time you're done with your plan, we'll know what caused the flash crash.

--Brent Hunsberger does not give individual financial advice, but welcomes comments and questions about his column or blog.

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