Time to Stress Test Your Retirement Plan

By Scott Neal

As I am writing this, most of the big banks have just reported the results of their stress tests conducted by the Federal Reserve. The tests are imposed by the regulators to determine if the banks can meet ongoing obligations during a major credit or liquidity crisis.  The most serious scenarios used to test the banks are 13 percent unemployment, a 50 percent drop in the Dow Jones Industrial Average, and a 21 percent decline in residence values. Citigroup, SunTrust, MetLife, and Ally Financial were the four, out of 19, that failed the stress tests during March.  But today, I want to address a different kind of stress test and no, it does not involve treadmills.

Many of you have at least seen The Number from your financial advisor or heard it advertised. You know The Number I am talking about; those seven or eight digits that traditional financial planning has said you need to have invested as you retire in order to have a withdrawal rate that replaces your current income. Actually, it’s more likely the number that the firm who advertises it wants you to have invested with them. Some of you have even found relief in knowing that you have more than enough to hit that number. But without a good deal of analysis, The Number is not very reliable. There are simply too many moving parts.  Online tools that ask 3 or 4 questions and spit out the number are not worth the effort.  Even if The Number were completely reliable, most people have not even considered subjecting it to a variety of stress tests once they have it. If there ever was a time to do that, it is now.

We believe strongly that saving to achieve The Number is really the wrong target.  So is developing a smooth withdrawal rate. A better target is a smooth  living standard determined by the amount of money one can safely spend each year adjusted for inflation until age x. An achievable steady pace is preferred over one that gets disrupted during retirement when the earning years are over. In the course of performing financial planning for our clients, our firm calculates the client’s maximum sustainable living standard. We use age 100 of the youngest spouse as the final year of the plan, but a good stress test would be to test to age 110 or even 120.  Each time the relevant answer is the amount of money available to spend.  Living longer means that your maximum sustainable living standard goes down.  Of course, we don’t think that intentionally living shorter lives is the answer.