The beginners guide to retirement part 12:Stress test your retirement plan

The best retirements are planned. You know what you want to do in retirement. You know how much it will cost. You know how much you will need saved. Less surprises will mean less stress and a greater likelihood of outliving your money.

The problem is life doesn’t always work as planned. We may experience a stock market crash the same year we retire. We may get sick and need costly intervention. We may live to the age of 100. Inflation may increase out of control, making everyday expenses much more expensive.

We need to do our best to anticipate and plan for these unfortunate events.


How do we plan for the unknown?

Some of the most common retirement roadblocks that I can think of include:

  • A 50% market crash in the first year of retirement

  • Living until age 100

  • High inflation

  • Not having enough saved

  • Superannuation not being available when I reach retirement age

  • Not having enough cashflow to cover expenses

  • Underestimating our expenses

  • Being bored

You can draw your own list of retirement fears or worst case scenarios, but I will now go into each of my fears and how I plan to manage them.


1/. A 50% market crash in the first few years of retirement.

The day we retire is when we have the most amount of money we have ever had. A large sharemarket crash during this first few years of retirement is a huge hurdle for two reasons. It is a substantial amount of money and at this point, we have the longest amount of time until we leave this planet. A crash later in retirement is not as significant as early on as we have less years to provide for. Likewise, a crash early on in our savings has a small impact on our returns. For more details on sequence of returns risk read part 4 and part 5 of the retirement series.

Let’s assume we have $20,000 at age 25 and experience a 50% crash. We will be left with $10,000. Yes, a big loss but easily recoverable. Now imagine a 50% crash as a 65 year old when we have $500,000. We will experience a loss of $250,000. That is 25 times the amount of our crash at age 25.

Not only have we experienced such a large loss, but we are less able to recover at this age. When we are younger we still have many years of income and cash accumulation left. Whereas in retirement, we are less likely to be accumulating money through work. In fact, we are more likely to be decumulating/withdrawing money, making a recovery to your situation very challenging indeed.

To combat this, I plan to reduce my exposure to stocks. I am currently 85% invested in stocks, 15% in fixed income. This is considered a growth portfolio. As I enter retirement I plan to have a stock allocation of just 40-50%. This is more of a balanced/conservative portfolio and is a risk management strategy. So if I do experience a large stockmarket crash early in retirement, then less than half of my portfolio would be affected.

Using the example above, instead of losing $250,000, I would lose $125,000. Still a big hit, but much better than $250,000. Yes this strategy will limit any gains made, but I feel more comfortable early in retirement with making less gains if it means potentially making smaller losses. 

This ‘safer’ portfolio raises another issue though. We are living longer lives and I need my portfolio to last for up to 50 years or more if I retire at 50.


2/. Living until 100 years old

30-40 years without a regular income from work is a real possibility for some people. That is a long time to be retired and a large amount of savings and a good retirement plan is needed to meet this challenge.

I am planning to live to 105. My financial plan is based on this. Then, if I pass away at age 95  I will ensure I do not run out of money. This is much better than planning on living to 85 years old and living to age 95. In both scenarios I have lived to age 95, but in one scenario I have run out of money and the other I haven’t. This is a result of conservative planning.


3/. Not having enough saved

Living so long raises the concern of not having enough money. Common advice is to put your money in ‘safe’ asset classes. Although you are unlikely to lose money, you will also not gain anything. With the very real impact of inflation, we need our investments to grow or we run the risk of running out of money. This advice is ok if you have saved 40 times your annual expenses. But the majority of us have saved far less than that and need some risk.

You can read part 3 of the retirement series to get a rough starting point for how much you need to retire. I plan to save 30 times my expenses, which works out at a withdrawal rate of approximately 3.3%.

To combat inflation, I will be using an increasing equity glidepath strategy (discussed in part 5) where I increase my exposure to stocks as I age. This ensures a low stock allocation early on to soften the impact of undesirable sequence of returns, and a growing stock allocation over time to help my money last for a long enough time.


4/. High inflation

The cost of living increases over time. More often than not it is gradual. 2-3% per year. Some years though we may be in for a shock experiencing high inflation of 5% or more. 4% in 2007 and 2010 have been the highest in recent memory. The 80’s frequently experienced inflation of 15-17%. This can happen again. It’s not likely, but if you want to stress test your retirement plans you should prepare for worst case scenarios.

As mentioned already, one strategy to combat inflation I am employing is an increasing equity glidepath. Stocks tend to perform better in high inflationary economies than ‘safer’ assets such as bonds and savings do.

I also plan to keep my rental apartment. Rent expense tends to at least keep up with inflation, which means I can receive income at least that of inflation.

During periods of extremely high inflation I can also reduce my spending. If I don’t spend then inflation will have no effect.


5/. Superannuation not being available when we reach retirement age

If you plan to receive NZ Super and then it is removed, you will be in all kinds of trouble. Your retirement calculations will fall short and you will not have saved enough money.

If you are more than 10 years from retirement, the best thing you can do is plan for your retirement with the assumption that you won’t receive any superannuation income. Then if it is removed or reduced, you will be prepared to handle that. If there are no changes made to the superannuation system then that will just be the icing on the cake.


6/. Not having enough cashflow to cover expenses

In New Zealand, we tend to have a lot of our net worth in housing. We buy the best house we can afford, pay off the mortgage, and then start saving. Yes, all going well we have a paid off house, but very little saved in other investments.

Having a paid off house does not pay the bills. Unless you plan to rent it out or downsize. We need to ensure we have sufficient money saved in other asset classes so we can pay our annual expenses.

I will have the cashflow from my rental apartment. I will also have bonds that I can either sell or receive coupons. Stocks will also make up part of my portfolio that I can also sell or receive dividends. I also plan to hold 2 - 3 years worth of expenses in emergency savings that are easily accessible. This is so that I don’t need to draw down from my stocks during a market crash.


7/. Underestimating our expenses

If you aren’t retired yet, you won’t know for certain what your annual expenses will be. You can take a good guess, but it may not be right. Our ideal retirement life may change once we actually retire and realise we want to live retirement in another way. Or we may just assume that our retirement expenses will be the same as our current expenses, without actually thinking about what a typical year in retirement will look like for us. Retirement may be more costly.

The key to navigate this is to have a clear idea in your head of what you want your retirement to look like. Break it down per year, per week and per day. What will you do on a daily basis? What do you want to achieve each year? How will you fill your time? These answers will help you determine your retirement lifestyle. Once you have a clear idea then you can work out the costs of this lifestyle.

Another strategy you can employ is to live as close to your desired retirement lifestyle before you retire, while you are still working. This is basically a test run of your retirement. Then you will get both a great idea of if this is the lifestyle you want and what the expenses will be. The benefit of doing this while still working is that you can continue to work for longer or work for less depending on your findings. It is much easier to continue working, than it is to quit and find work again.


8/. Being bored

As discussed in part 7, this is the importance of retiring to something, not from something.

As with point 7, I plan to do a test run before I actually retire. Where I live the life I want to in retirement before I quit work. This can be done during a 4 week annual leave period, or maybe longer if you have it. This will ensure I am happy with how my future days will be filled. Make sure you have a long list of things you want to achieve and you may even find your retirement days are busier than your working days. Otherwise you will find yourself bored and not enjoying your retirement.



Final Thoughts


I have discussed my biggest fears in retirement. Yours may be similar, or they could be different. The key is to recognise them, embrace them, and plan to mitigate them.

Life does not always work out to plan, but the more we can plan for, the less surprises there will be. It is important to recognise what could happen and make the unknown known.

Flexibility is a critical component of retirement. Just because we may go into retirement with a plan to spend 3.5% of our portfolio each year doesn’t mean we will. In years of a poor performing economy it would be wise to reduce our spending to maybe 3%. Just because I plan to keep my apartment, doesn’t mean I will if there was a sudden surge in the value of apartments.

I will have a comprehensive retirement plan but I understand that things will happen. As long as I can remain flexible and willing to adapt I know I will have the necessary armour to protect us from attack.

Build up your own defences and take them out for a trial run to expose any holes you may have in your strategy.

That winds up the 12 part retirement series. We have only touched the surface with these topics, but it is a good starting point for things to consider with regards to your retirement planning. 

Thanks for reading. See you next week.