Stress-Testing Your Plan

Your Plan vs. Reality

🔄 Quick Recall: In the previous lesson, you built your Social Security claiming strategy and healthcare funding plan — addressing the two biggest wildcard expenses in retirement. Now it’s time to stress-test your entire plan against the uncertainties that could derail it.

A retirement plan built on averages will fail in a non-average world. Markets don’t return a smooth 7% every year — they crash, recover, stagnate, and boom unpredictably. Inflation doesn’t hold at a constant 3%. And you don’t know how long you’ll live.

Monte Carlo simulation is the tool that bridges this gap between your plan and reality.

What Monte Carlo Simulation Does

Instead of assuming average returns, Monte Carlo runs your plan through thousands of random market sequences. Some simulate years like 2008 (markets down 37%). Some simulate the 1990s bull market. Most simulate something in between.

The result: a probability that your money lasts as long as you need it.

Tools for Monte Carlo Analysis

The Monte Carlo Prompt

Use AI to interpret and act on your simulation results:

I ran a Monte Carlo simulation for my retirement plan:

Inputs:
- Portfolio: $[X] at retirement
- Annual withdrawal: $[X] (adjusted for inflation)
- Allocation: [X]% stocks, [X]% bonds
- Time horizon: [X] years
- Social Security: $[X]/month starting at age [X]

Results:
- Success rate: [X]% (portfolio lasts the full period)
- Median ending balance: $[X]
- 10th percentile ending balance: $[X] (worst 10% of scenarios)
- Main failure scenarios: [if the tool provides this detail]

Help me interpret:
1. Is my success rate adequate? What do planners typically target?
2. What's the biggest risk in the failure scenarios?
3. What single change would improve my success rate the most?
4. If I implement a flexible spending rule (reduce withdrawals
   10% when portfolio drops 15%), how does that change the outlook?

✅ Quick Check: Why is the 10th percentile outcome more useful than the median? Because the median shows what happens in a typical scenario — and typical scenarios usually work out fine. The 10th percentile shows what happens if you’re unlucky: poor market returns early in retirement, a prolonged bear market, or higher-than-expected inflation. Your contingency plan needs to address this scenario, not the median one. If the 10th percentile leaves you broke at 85, your plan has a serious vulnerability.

The Three Biggest Risks

1. Sequence of Returns Risk

The order of returns matters as much as the average. A 30% market crash in year 2 of retirement is far more damaging than the same crash in year 15 — because early withdrawals combined with losses permanently reduce your portfolio.

Model sequence of returns risk for my plan:

Compare two scenarios (same average return of 7% over 25 years):
1. Bad returns first 5 years (ranging from -15% to +3%),
   then strong returns (10-15%) for remaining years
2. Strong returns first 5 years, then poor returns

Portfolio: $[X], withdrawing $[X]/year.
Show the ending balance for each sequence.
Why is the difference so dramatic despite identical average returns?

2. Inflation Risk

Stress-test my plan against different inflation scenarios:

Run my plan (Portfolio: $[X], Withdrawal: $[X], Horizon: [X] years) at:
1. 2.5% inflation (below historical average)
2. 3.0% inflation (historical average)
3. 4.0% inflation (above average, sustained)
4. 5.0% inflation (high inflation scenario)

For each: ending portfolio balance and success rate.
At what inflation rate does my plan start to fail?
What adjustments would protect against 4-5% inflation?
(More TIPS? Higher equity allocation? Lower initial withdrawal?)

3. Longevity Risk

Model longevity risk for my retirement plan:

Run my plan to these ages:
1. Age 85 (20 years of retirement)
2. Age 90 (25 years)
3. Age 95 (30 years)
4. Age 100 (35 years)

My family longevity: [parents' ages at death if known]
Current health: [status]

For each horizon: success rate and ending balance.
At what age does my plan start to fail?
What's the cost of adding longevity insurance (an annuity
that pays starting at age 85)?

Building Your Contingency Plan

Based on your stress tests, create a written plan for adverse scenarios:

Based on my stress test results, help me create a contingency plan.

Trigger 1: Portfolio drops 20%+ from peak in early retirement
- Action: [reduce spending by X%, defer large purchases, etc.]

Trigger 2: Inflation exceeds 4% for 2+ consecutive years
- Action: [adjust allocation, reduce discretionary spending, etc.]

Trigger 3: I'm still alive at age [X] with less than $[X] remaining
- Action: [consider annuity, downsize, reduce withdrawal rate]

Trigger 4: Major unexpected expense (medical, family emergency)
- Action: [which account to draw from, how to adjust future plan]

For each trigger: what specifically should I do, in what order?

✅ Quick Check: Why is having a written contingency plan important even if you never use it? Because decisions made under financial stress are almost always worse than decisions made in advance. If the market crashes 30% in your second year of retirement and you don’t have a plan, you’ll either panic (sell everything, lock in losses) or freeze (do nothing, watch your plan deteriorate). A written plan says “if X happens, I do Y” — removing the emotional decision-making during the most stressful financial moments.

Key Takeaways

• Monte Carlo simulation tests your plan against thousands of random market scenarios — target an 80-90% success rate for adequate margin
• Sequence of returns risk (poor markets in early retirement) is the biggest threat; flexible spending rules that reduce withdrawals during downturns add 5-10% to success rates
• Inflation above 3% compounds into enormous spending increases over 25-30 years — test your plan at 4-5% inflation to find your breaking point
• The 10th percentile outcome matters more than the median — your contingency plan should address worst-case scenarios, not average ones
• A written contingency plan with specific triggers and actions removes emotional decision-making during financial stress

Up Next: You’ll assemble everything into a living retirement plan — a complete document that evolves as your life, markets, and goals change.