Think Your Retirement Plans Are Solid? Stress Test Them First

A retirement plan is just that — a plan. It can be hard to really know if it’s going to carry you sufficiently through actual retirement until you get there.

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What if you could, however give your retirement plan a preview before you actually arrive? Technically, you can; it’s called a “stress test.” Finance experts explain how to do it.

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What Is a Stress Test?

Stress testing your retirement plan is a way of determining how your retirement savings will behave during a down market after you retire, according to David Kanani, finance expert and president of Kanani Advisory Group.

“It will help to see whether you are taking more risk than you should, or if you might need more growth in your portfolio to meet your needs.”

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How To Do One

For retirees, a stress test could mean checking whether their income streams, investment strategy or withdrawal rate would still work if the economy takes a downward turn, according to Tom Buckingham, chief growth officer at Nassau Financial Group.

“It’s a shift from hoping for the best to preparing for the unexpected — and then building a plan that’s resilient enough to adapt,” he said. A proper stress testing of your portfolio should indicate whether you are taking on too much risk or if you don’t have enough equities for growth, Kanani pointed out.

Reducing Risk

The biggest risk to any retirement savings that’s invested in the market is taking on too much risk, Kanani said. A stress test should help you see how well diversified your portfolio is — and will be — by retirement.

“A well-balanced portfolio that includes stocks and fixed products such as bonds or fixed annuities should help guard against the pressures of inflation and high interest rates,” Kanani said.

If most of your savings are stored in cash in a bank or if your retirement income is dependent on fixed income sources, then stock market risk isn’t your biggest concern — inflation is, Kanani added.

“Fixed income sources that will only pay a certain amount will lose value over time as inflation rises. The same is true of money sitting in a traditional bank account; they rarely earn enough interest to offset inflation,” Kanani said.

Mindset Test

As much as a stress test is a financial test, it’s also an attitude and lifestyle review, according to Dr. Stephan Shipe, Ph.D., CFA, CFP and founder of Scholar Financial Advising and a finance professor at Wake Forest University.

“The closer you are to retirement, the less impact each additional dollar of savings actually makes. Saving an extra $30,000 the year before retirement won’t change your trajectory nearly as much as getting clarity on whether your lifestyle, schedule and financial plan are actually sustainable,” he said.

In many cases, it’s smarter to invest in that clarity now while you still have a paycheck to fall back on, he pointed out.

Dr. Shipe typically recommends a six- to 12-month test drive. “Anything shorter may not give a full picture. Anything longer often becomes unsustainable while still working.”

Use a Stress Test Calculator, but Also Talk to a Professional

Most investment platforms like Fidelity, Schwab and Vanguard offer their own version of a ‘stress test’ calculator that shows a version of how your current retirement plan might perform under certain circumstances, Kanani explained.

However, he recommended you also seek professional help. “You don’t want to put your life savings in any unnecessary risk. A professional can help run several scenarios to help ensure your financial decisions are being made with confidence.”

Fixes to Common Problems

Stress tests often reveal current or common problems in your investment strategy, Buckingham said.

Early market declines, combined with withdrawals, can reduce a portfolio’s ability to generate income over the long-term, he pointed out. “One way to help mitigate this risk is by incorporating fixed annuities early in retirement, providing a guaranteed income stream that isn’t impacted by market fluctuations.”

A stress test can also help you plan ahead for rising costs of healthcare and increased longevity, which can drain savings quickly.

Longevity amplifies every other risk because, the longer you live, the more exposure you have to market volatility, inflation and unexpected health costs.

If You Fail the Test

If you “fail” the stress test, don’t panic, Buckingham said. Look at which “levers” you can adjust, such as revisiting spending, diversifying income sources and optimizing your Social Security timing.

Kanani added, “If your plan does not pass the stress test, figure out which problem you are facing. If you are taking on too much risk, you can seek out traditionally lower-risk investments to focus on the preservation of your assets. If you are not earning enough on your investments, you can look for more growth-oriented options.”

“Lastly, think about maintaining flexibility in your retirement plan — whether through part-time work, downsizing or adjusting withdrawals during down years,” Buckingham said.

A failed stress test doesn’t mean your retirement is off course — it simply reveals where your plan might fall short if life throws a curveball.

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This article originally appeared on GOBankingRates.com: Think Your Retirement Plans Are Solid? Stress Test Them First