Why You Need to Stress-Test Your Financial Plan
When we think about planning for retirement, we often imagine the best-case scenario: Our investments flourish, Social Security benefits arrive promptly, and medical expenses stay under control. While optimism is a terrific attitude to have, a comprehensive financial plan is like a good home—it needs to withstand not just sunny days but also unexpected storms.
This is where stress-testing your financial plan comes into play. A stress test is a simulation to assess how well a system functions under severe conditions. This means analyzing your financial plan’s resilience against potential downturns in the market, increased medical costs, or other unforeseen circumstances that could affect your retirement savings.
Below, we discuss why it’s crucial to stress-test your financial plan and provide steps to accomplish this essential task.
Why You Need to Stress-Test
Discover weak links: By putting your plan under a microscope, you help identify vulnerabilities. Is your portfolio overly concentrated in one sector? How would a market downturn affect your retirement income? Knowing your weak spots allows you to fix them in advance.
Confidence in decision-making: A stress-tested plan can bring peace of mind, as you may feel more prepared for uncertainties, enabling you to make informed decisions rather than panicking during a crisis.
Optimize spending and saving: A stress test can help you determine how much you need to save today to maintain your lifestyle, even in a worst-case scenario. This information can help you balance present enjoyment with future security.
Evaluate estate plans and legacy goals: It’s not just about you. If you have a family that might rely on your financial legacy, a stress test could help safeguard their future.
Steps to Stress-Test Your Financial Plan
Evaluate scenarios: Create a list of events that could seriously impact your financial plan. These could include market downturns, higher inflation, lower-than-expected Social Security benefits, or unexpected healthcare costs.
Run simulations: Consider working with a financial advisor to run simulations based on various scenarios. Many software tools can model different economic or market conditions and their potential impact on retirement savings.
Assess asset allocation: Check how different scenarios may affect your portfolio. Should you diversify more? Do you need to adjust the risk in your investment choices?
Look at income sources: Make sure you’re not too dependent on a single income source. Diversifying income streams can include Social Security, pensions, investments, and rent.
Review your emergency fund: How many months can you sustain your current lifestyle without income? Aim for at least three to six months of living expenses in a liquid account.
Plan for healthcare: One of the most unpredictable and potentially costly aspects of retirement is healthcare. Use your stress test to evaluate how much to set aside for healthcare costs. Have a plan for paying for long-term care, as those expenses can add up fast.
Review and adjust: Take corrective measures to fortify your plan, and repeat the stress test periodically, especially after significant life changes or financial events.
How a Financial Advisor Can Help
A financial advisor can use specialized tools and provide insights to identify the stress cracks in your plan and advise you on how to repair them. As fee-only fiduciary financial advisors, we bring an objective perspective to creating, testing, and updating a financial plan so you can feel prepared for retirement.
Schedule a complimentary consultation with one of our fee-only financial planners to discuss your personal situation.
This material was written in collaboration with artificial intelligence (ChatGPT) derived from sources believed to be accurate. This information should not be construed as investment, tax, or legal advice.