Stress Testing Retirement

The August 13th edition of The Wall Street Journal included an article that talked about the impact of market volatility on people’s retirement plans. (“Which Way to Retirement?” Article available at with paid subscription.)

One woman quoted in the article said that she was planning on retiring in November until her investments stumbled. Now, she says, she is going to have to work longer or take on part-time employment. Another man said that recent market events led him to put off his retirement for at least two years.

It’s true that the stock market, as measured by the S&P 500, was down about 10% for the previous month when the article was published. But if your retirement plans can be derailed by a 10% decline in the stock market, then quite frankly you’re in for a long, long haul, because those 10% corrections happen a lot more often than people think.

According to Capital Research and Management Company (courtesy of Fidelity Investments), the period of 1900-2010 saw the following average frequency of market corrections:
• 5% decrease: 3 times/year
• 10% decrease: once per year
• 20% decrease: once every 3.5 years

Just last year, between April 13 and July 5, the S&P 500 Index (a broad measure of US Large Company stocks) declined almost 16%, causing the year-to-date return at that point to be about -6.5%. Of course, most people have already forgotten that, since the index actually finished the year up a little over 15% (including dividends).

Although though the S&P 500 lost about 5.4% in August, it was down just around 1.77% for the entire year. Obviously we have no idea if it will end the year higher, lower, or right where it is. But the larger point is that intra-year market corrections happen!

And all this assumes an investment portfolio comprised of 100% stock. A more balanced portfolio of 60% stocks and 40% bonds (which is probably more appropriate for a soon-to-be retiree than an all-stock portfolio) was actually up about 1.1% for the year, as of August 31st.

Given the frequency of market downturns, a retirement plan that gets derailed by that small of a shock is probably in need of some reexamination and goal refinement.

We think that it’s important to stress test your retirement plan before you actually go through with it. One way we do this with our clients is to model a “What If…?” scenario, in which simulate a couple of really bad years of investment returns right at retirement and look at the outcome. More often than not, our clients can actually sustain some pretty nasty shocks to their portfolios and still accomplish their financial goals.

We’ll also try to figure out a client’s Loss Cushion, where we determine how much a client can lose immediately and still have a reasonably high enough probability of achieving their goals.

We know that market corrections will come; we just don’t know when. Stress testing your plans should help keep you calm when the corrections happen and, more importantly, prevent you from making any panic-induced decisions that could seriously derail your retirement future.

About Ben Birken

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