When you think of your retirement planning, what do you think of? Having enough money to build a big nest egg? Replacing your paycheck over the rest of your life? Your retirement planning should not be just about those things. Your retirement planning should also be about preparing for uncertainty. Those “what ifs” of your life that no spreadsheet can fully predict. A retirement plan that looks solid on paper can still crack under the pressure of real-world surprises. How would a market crash or downturn affect your plan? What if you experienced higher inflation than you previously thought? What if you had unexpected medical bills?
That’s where the idea of a stress test comes in. Just as banks test their balance sheets against crises, you can test your portfolio against the kinds of risks that don’t show up in smooth, average return projections. A stress test takes your retirement portfolio and asks questions. What happens if the market downturns in year 4, or say in year 10? What if inflation spikes to over 4% for 10 years during the plan? What if I live ten years longer than expected, or my spouse dies earlier, and I lose part of their social security?
The purpose isn’t to scare you. It’s to build your confidence. Confidence that comes from knowing ahead of time how your plan, your savings, and your retirement income strategy can adapt, before the pressure from an unexpected event occurs.
In this guide, we’ll walk through how to stress test your retirement plan, the tools and strategies available, and practical adjustments you can make to safeguard your financial future.
What Does It Mean to Stress Test Your Retirement Portfolio?
At its core, a stress test is a financial “what if” exercise. In retirement planning, it’s the process of testing your investment portfolio against negative scenarios that could derail your income and savings.
Unlike a standard risk assessment, which might tell you how “conservative” or “aggressive” your mix of stocks and bonds is, a stress test digs deeper. It asks:
- What if there’s another financial crisis, like 2008?
- What if inflation stays above 5% for a decade?
- What if medical costs double your expected spending?
- What if your spouse lives to 100, stretching your funds further than you planned?
By running these kinds of tests, you uncover vulnerabilities hidden behind optimistic averages. A retirement portfolio that looks fine in a normal forecast might fail under stress. Knowing that risk now allows you to know how you will be able to adjust when life forces the issue.
Here is another important point. A lot of plans have a “probability of success”. However, they do not go a step further and let you know beforehand what short-term adjustments or tweaks you could easily make to get back on track. Let’s say your projections had a “probability of success” of 100%. You might feel pretty good. But what if a good portion of those simulations ended with less than $2,000 in the bank. Would you really feel that confident? It is never just a simple “pass/fail”.
Key Risks That Can Derail Retirement Savings
The strength of your retirement plan isn’t measured by how it performs in good times, but by how it holds up when things go wrong. Here are the big risks stress testing can reveal:
1. Market Volatility and Market Downturns
The stock market has always moved in cycles with booms, followed by downturns. We cannot expect the “Magnificent Seven” stocks or AI stocks to keep the market running upward forever. Retirees who need to withdraw income during a market crash face what’s called “sequence of returns risk.” A sharp drop early in retirement can permanently reduce the size of your nest egg, even if the market soon recovers. The reason for this is because, given the same dollar withdrawal each month, those withdrawals will be a greater percentage of your account when the account is lower in value. This means you are digging into the principal at a greater percentage, thereby reducing the amount it can recover when markets resume going up.
2. Higher average Inflation and or periods of High Inflation
Inflation quietly erodes the purchasing power of your money. Over decades, even a modest inflation increase reduces how much your income covers. A period of high inflation, like the 1970s, can devastate retirees who rely on fixed income streams. Many retirement income tools cannot plan for inflation “spikes”. This occurs when inflation spikes up for five or six years, above some assumed average. The “average” inflation rate you assume over the life of your plan may be right, but that does not matter since you will need income every year; not just years of average inflation.
3. Longevity Risk
Living a long life is a blessing. This also means your savings must last longer. Outliving your funds is one of the greatest fears a retiree faces. With longer life expectancy, even well-designed financial plans can result in stress.
4. Health Care and Long-Term Care Costs
Health costs are unpredictable. A sudden illness, long-term care needs, or gaps in Medicare coverage can add six figures of extra expenses. Without planning, this can turn a solid retirement into a financial crisis.
5. Interest Rate Shifts
Low or rising rates impact bond values, mortgage costs, and cash flow. If rates rise quickly, the bond portion of your portfolio can lose value. If they stay low, retirees may not earn enough interest income. While it is important to diversify your sources of income, accurate predictions of future interest rates have never been repeatable.
6. Sequence of Returns Risk
This subtle (yet dangerous) risk happens when poor returns occur at the same time you’re withdrawing funds. It’s less about average returns and more about timing. Two portfolios, with identical average returns, can produce wildly different results if withdrawals start during a downturn. We witnessed this with retirees starting retirement in 1999 and 2007.
7. Unexpected Support for Children
In the last 15 years, we have seen many retirees overlook support for grown children. Even when the kids are adults, financial help with a house, college debt, or unexpected emergencies can quietly drain a retirement portfolio. What begins as temporary assistance often stretches into ongoing obligations, putting long-term financial goals at risk. Stress testing a retirement plan should account for these family pressures, ensuring your generosity doesn’t compromise your own security.
How to Stress Test Your Retirement Plan’s Portfolio
Stress testing isn’t guesswork. There are concrete ways to “test” your retirement plan:
1. Run scenarios using actual historical data from a specific time period. Ask yourself: “What would happen if my portfolio faced the 2008 crash? The dot-com bust? The pandemic shock of 2020?” You may have heard the saying that “History never repeats but it sometimes rhymes”. Market corrections are inevitable and should be expected, even if the exact reasons for it change.
2. Inflation modeling: Test both low inflation (2%) and high inflation (7% or more) to see how rising costs hit your income.
3. Longevity modeling: Assume you or your spouse lives to 95 or 100. How much pressure does that put on your funds?
4. Withdrawal strategy testing: Stress test different withdrawal plans to help see how it affects the capacity of your plan to be sustainable. The very best plans have “guardrails” that can automatically tweak your withdrawal rate (up or down) to maintain the current longevity of the plan. Markets and life will not stay the same for your entire retirement period. We all will tweak and adjust as circumstances change. You should at least have an idea how your cash flow will need to adjust.
5. Health care shocks: How does adding $200,000 in long-term care expenses affect your financial plan? In what scenarios is it unrecoverable?
6. Mixed scenarios: Combine challenges. For instance, what if you experience a market downturn at the same time there is high inflation. These aren’t hypotheticals. History has shown they can happen together.
Tools and Methods for Stress Testing
There are several ways to test retirement portfolios, each with pros and cons:
Monte Carlo Simulations
A Monte Carlo analysis runs thousands of simulations using random market returns to show a range of possible future results. Instead of predicting one number, it shows probabilities: maybe a 75% chance your money lasts 30 years, or a 25% chance of running out early. Monte Carlo is especially useful for visualizing return risk and uncertainty. Monte Carlos analysis does not try and predict the future; it is a tool that tries to show you reasonable probabilities of future events.
Scenario Analysis
This approach tests your retirement plan against specific past events such as replaying the financial crisis of 2008 or the inflation of the 1970s with your current portfolio. It’s intuitive because you can ask, “Would my portfolio have survived this, given how it is positioned today?”
Planning Software and Calculators
Financial planners and wealth advisors use professional software to run more detailed stress tests, incorporating taxes, health care, cash reserves, and other factors. DIY retirees can use online calculators, but they often lack the depth of professional tools.
Professional Guidance vs. DIY
You can run basic tests yourself, but a financial advisor or investment advisor can tailor stress tests to your unique financial situation. That’s where personalized investment advice makes the difference, because no two retirees face the same risks.
The very best software and tools combine all these characteristics. Unfortunately, they can be expensive for most investors.
Adjustments After a Stress Test: What the Results Tell You
This is the most important point: determining what adjustments may be required of you and having you consider what you would be willing to change. A good plan helps you clearly see these tradeoffs. The point of a stress test isn’t to scare you; it’s to show where your plan bends or breaks. From there, you can adjust:
- Rebalance asset allocation: If your portfolio is too heavy in stocks, think about adding stability with bonds, alternatives, or cash. If it’s too conservative, add growth assets.
- Withdrawal strategy changes: Switch from fixed withdrawals to a flexible withdrawal plan that adjusts to market performance.
- Spending adjustments: Separate essential from discretionary expenses, so you can cut back temporarily during a downturn.
- Income diversification: Maybe consider annuities, pensions, or guaranteed income sources to reduce reliance on the stock market.
- Tax strategies: Withdraw from accounts in tax-efficient ways to preserve after-tax income.
The Role of Diversification and Asset Allocation
Diversification is the classic defense, but it isn’t enough by itself. A portfolio that holds both stocks and bonds can still suffer if both fall during a financial crisis. Stress testing shows how your mix of assets behaves under pressure.
Key principles include:
- Growth vs. stability: Stocks drive long-term wealth, but they bring volatility. Bonds and cash reserves provide ballast but can have more trouble keeping up with inflation.
- Alternative assets: REITs, commodities, or private credit may respond differently during downturns.
- Liquidity: Having access to liquid assets prevents being forced to sell at bad times.
Practical Steps to Strengthen a Retirement Portfolio
Beyond testing, retirees can make their portfolios more resilient with these actions:
1. Maintain cash reserves: A year or two of living expenses in cash, or near-cash, can prevent panic selling during a market downturn.
2. Plan for health care costs: Consider long-term care insurance or earmarked funds. A recent study by Fidelity Investments discusses ways to better estimate long-term Health Care costs.
3. Review insurance coverage: Health, long-term care, and life insurance can protect your legacy.
4. Tax-efficient withdrawal strategy: Coordinate withdrawals from taxable, tax-deferred, and tax-free accounts. Your plan should include possible Roth conversions and the appropriate timing of those.
5. Prepare for “what ifs”: Early retirement, forced retirement, or supporting family can all stress a financial plan.
Stress Testing Retirement Portfolios: FAQs
How often should I stress test my retirement portfolio?
At least every couple of years, or when there’s a major change in your financial situation, the market, or your life.
Is stress testing only for wealthy investors?
No. Every retiree, whether with $400,000 or $4 million, can benefit. Stress testing is about protecting income and building confidence, not just about wealth.
What’s the difference between stress testing and a financial plan?
A financial plan sets your goals and strategies. Stress testing pushes that plan to the edge to see if it breaks.
Do I need special software?
Yes. The combinations of different scenarios, their specific timing, and the varying options just cannot be truly analyzed in something like Excel or a $25 per month website. As we mentioned in a prior post, a married 62-year-old couple can have over 9000 different scenarios, simply for claiming Social Security income. Specialized, advanced software adds depth. A wealth advisor or financial planner has access to tools most individuals don’t.
What if my portfolio “fails” a stress test?
That’s valuable information. It means you can adjust your investment management before life forces major change.
How Can Our Stress Tests Help with the Success and Sustainability Of Your Retirement Portfolio
The success of your retirement plan will not depend on rigid percentages. It will be determined by how well you assess future risks and how flexible you can be. Ultimately, it lies in our adaptability and choices.
We start by having a defined and structured process for making evidence-based adjustments as conditions unfold. But, those adjustments are always considered within the context of your goals, your fears, and your situation. That results in personalized investment advice.
Retirement plans must be personal. There can be no other way. Spend a few minutes with us to see if we are a good fit for each other and if we can help you craft your retirement income plan.
The Porter Investments Strategies were developed by our President and founder, Bob Porter. His prior work at Fidelity Investments allowed him the opportunity to advise and study a diverse group of investors.
