Can your retirement plan survive all 6 stress tests?

"What can go wrong with this picture?"

This is one of the questions I like to ask myself when we finish working on a financial plan for a new client or updating one for existing clients.

I don't always say it out loud or bring it up in client meetings but it's always in the back of my head.

As Yogi Berra famously said, "predictions are hard, especially when they are about the future."

So if you already have a plan in place or are thinking about implementing a new one, these are my top 6 "stress test" ideas for you to think about.

1.) Market Underperformance

I will start with the obvious risk.

There are really two versions of this stress test that we think about at Capital Squared.

The first is a sudden market drop. Remember the post "Liberation Day" drop in 2025 or the Covid market in 2020?

A 20% or 30% decline in your portfolio can be jarring, especially if you're getting close to or already in retirement.

I'm sure many of you heard about the concept called “sequence of returns risk”.

If the market drops right when you need to sell funds to live off of, you have to sell at a loss and lock in those losses permanently.

The main way to plan for this is to make sure you have plenty of liquid and stable funds to live off of while the market recovers.

This is a proactive and ongoing approach, so you can never really "sleep on" this one.

The second version is more subtle but just as important.

"Past performance is no guarantee of future results" is what I frequently say in our client meetings and for a good reason.

Simply put, the market averages of the last decade aren't guaranteed for the next.

How comfortable would you feel with your retirement plan if your investments grew by 1% or even 2% less annually?

If your plan falls apart on slightly lower returns, you may need to make adjustments in other ways to make it more resilient.

My bottom line is to make sure our clients avoid delaying retirement since it's not always within your control.

But it does help to understand that perhaps you will be just fine if your average returns are 6% instead of 7%, just as an example, in the long run.

This can also lead to other suggestions such as saving more in the beginning of your retirement or increasing the investment risk of your portfolio if you still have time.

2.) Higher Taxes

Tax laws change.

Many people erroneously assume they will be in a lower tax bracket in retirement simply because they no longer work.

Even without any major tax law changes, if you have Required Minimum Distributions (RMD), that could bump you up to a higher tax bracket without you being mentally prepared for that.

Quick reminder here. Required Minimum Distributions are the amounts the IRS requires you to withdraw from your retirement accounts starting at age 73.

Now, the reality is that there is a limit to how much you can really save on taxes.

You can minimize but very rarely eliminate them…

What you can do is make sure you're using all the strategies available to you to not pay more than you need to.

This could look like proactively doing Roth conversions when they make sense, such as in low income years.

A Roth conversion is when you move money from a pre-tax retirement account into a Roth account, paying the taxes now so you don't have to pay them later.

How much is at stake here?

When you look at the balance of your pre-tax accounts, mentally adjust for 20 to 30% less (depending on the size of your account).

This is, of course, an oversimplified perspective but not unrealistic.

At the very least, you want to prevent the illusion that you have more than you actually do when adjusted for taxes.

3.) Reduced Social Security

Without exaggeration, every single client of mine is concerned about Social Security to a certain degree.

The Social Security trust is likely going to reach a point in the near future where changes will have to be made.

This wouldn't result in zero Social Security benefits, but be prepared for some adjustments.

The nominal amount of your benefit perhaps will stay the same but it can be reduced by higher Medicare premiums, especially if you are in a higher bracket.

There are many sneaky ways to reduce the benefits without necessarily making a direct cut to the amount you receive…

What can you do about it? Ideally, you wouldn't want Social Security to be responsible for more than 1/3 of your retirement income.

4.) Longevity Risk

Outliving your money is a top retirement fear (and Capital Squared's specialty is to make sure this doesn't happen).

I hear this all the time, "What happens if I do live into my 90s or even 100s?"

Adding 5 or 10 years to your life expectancy can have dramatic impact on how much you can safely spend each year throughout retirement.

The good news is that there are many ways to handle this issue if you have enough time to plan for it.

One solution that can help is making sure the mix between stocks and bonds in your portfolio isn't too conservative too early on in your retirement.

This is a very common mistake!

This is a rather tricky balancing act and I would rather not go into it in much detail here.

But if you want to read more, check out our recent newsletter that discusses how we approach this concern with our Fortress Financial Plan approach.

5.) Inflation Risk

Inflation is inevitable and we all know this.

The big mistake I see people make is forgetting to adjust their expected returns by the rate of inflation.

So they will assume their portfolio will grow by 8% annually without subtracting the average inflation rate of at least 3% (so 5% net growth).

To put it another way, are you only accounting for the growth your portfolio has and neglecting the growth of what living life costs?

The real solution to inflation risk is to make sure your portfolio has enough in growth investments to limit the impact in the long run.

Again, this is a more technical point but I will just say that bonds are not good at protecting you against inflation and stocks have a much stronger track record.

6.) Increased Healthcare Costs

If you don't have firsthand experience caring for an aging loved one, it's very easy to underestimate what you might need for medical care when you are older.

Just to give you a real example, one of our clients started paying about $87,000 a year for in home care. That number has since climbed past $200,000 as her needs progressed.

There is a lot of available research on the topic that you can search for to get average costs of Long Term Care (LTC) in the city you plan to retire in.

Be careful here!

First of all, healthcare costs inflate at a faster pace than the consumer inflation rate, closer to 4 or 5% or even more in some places.

Even more importantly, they can grow almost exponentially if you need more care later in life.

The bottom line is you need to have a plan that accounts for this risk early on so that you are not unpleasantly surprised later in life.

What does this mean for you?

I hope this helps you think through some of your potential blind spots as you prepare for retirement.

A great retirement plan shouldn't just work in a perfect economic climate, with perfect health and great investment returns.

It needs to be both durable and flexible.

If your plan isn't withstanding one of these stressors, how could you adjust it to improve your results in the long run?

As always, if you have any questions, feel free to reach out. I enjoy hearing from you!