Stress tests determine how viable something is in various “what if?” scenarios. For example, in a cardiac stress test, a patient connected to an electrocardiogram runs on a treadmill to measure the rate and rhythm of their heart. Doctors can use the results of such a test to determine the patient’s risk of heart failure. Similarly, a stress test of your retirement plan can help determine how well it will hold up under real-world circumstances.
Thankfully, this kind of stress test doesn’t require you to break a sweat—all that’s required is asking yourself a few “what if?” possibilities that the future may hold. Here are three “what ifs” worth considering.
1. What if Stock Market Returns Are Lower Than Expected?
“The market always goes up in the long run!” Stock market investors have probably heard—and counted on—this phrase more times than they can remember.
And while looking at historical stock market charts can be reassuring to long-term investors, the narrative is a bit more complicated for retirees.
Someone decades away from retirement may not be too worried about a flat or even declining stock market because they can be fairly confident that, no matter what the market does in the short term, the investments they hold today will be worth more when they return in 30 or 40 years. And a short-term downtown may even allow them to make investments at something of a discount.
But retirees don’t necessarily have the luxury of waiting out a market that’s producing minimal gains or even losses—they have already accumulated their assets and need their value as well as the income they produce to maintain some minimum acceptable level for them to have a comfortable retirement.
So one way to stress test your retirement plan is to project what the stock portion of your portfolio will look like over the course of your retirement, not only at some “typical” average annual rate of return—such as 7%—but at a “lower” rate as well—such as 2%.
Even at this lower expected rate of return, will your assets still be able to provide you with a comfortable standard of living throughout your retirement? If not, your current retirement portfolio may not be large enough to sustain you throughout your retirement, and you may need to spend a few more years working to increase your contributions before you retire.
2. What if You Live Longer Than Expected?
At a high level, a successful retirement plan provides enough money for you to sustain the lifestyle you desire until you pass away.
Obviously, somebody who retires at 65 and lives until they are 85 will need their retirement to last 20 years. But what if this individual lives to be 100 years old? Their retirement will need to last them 35 years—75% longer than if they had passed away at 85.
You may have an idea of how long you will live based on your current health and family history, but your body—as well as ever-advancing medical technology—may surprise you.
In fact, according to Pew Research, the number of people who are 100 years old or older is expected to increase by over sevenfold by 2050.
This means that many of today’s 70-year-olds, who may not expect to make it to 100, actually will.
And their longer lifespans, of course, mean more years their retirement savings will need to last.
To stress test your retirements plan to get an idea of how long your savings will last, project your nest egg at a lower-than-average rate of return, as suggested in the previous section. Then, project for a longer than expected time, such as the number of years your retirement will last if you live to be 100. Also, consider projecting gradually increasing healthcare costs for this duration.
If your current plan isn’t able to sustain you for a retirement spanning multiple decades, you may want to consider focusing on enhancing your lifetime fixed income sources in retirement. For most people, the simplest way to do this is to delay receiving Social Security benefits until age 70.
3. What if Inflation Hits Record Highs?
While projecting your investment returns as well as your length of retirement are important to stress test your retirement plan, don’t overlook the effects of inflation.
Your investment returns could very well come in well above historical averages over the course of your retirement. But if you enter retirement during an extended period of record inflation, your retirement resources may still deplete faster than you think. Combine lower-than-expected returns with higher-than-expected inflation, and without careful planning, you could be looking at a retirement train wreck.
If you’re currently estimating an increase in your retirement expenses of something like the Federal Reserve’s goal of 2% per year, consider projecting your costs at a much higher multiple, such as 8% or 10%. Remember that during the 1970s, food costs increased by an average of 8.1% per year—with 1973 and 1974 seeing increases of 14.5% and 14.3%, respectively.
If your retirement plan can’t keep up with high inflation, you may want to look at what lifestyle changes you can implement now to reduce your costs in the future.
Seniority is published by Finance of America Reverse LLC. The views expressed in this publication are those of the author alone and do not necessarily reflect the views and opinions of Finance of America Companies. This article is intended for general informational and educational purposes only and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.
