Your Retirement Portfolio Needs a Fire Drill Before the Next Market Drop
A simple stress test can show how your savings, withdrawals, and nerves might hold up in a downturn, so you can make changes while markets are calm.
The short answer
A portfolio stress test is a rehearsal. You estimate what a sharp market decline would do to your balance and your income plan, then decide in advance how you would respond. Doing this before a selloff gives you time to adjust calmly. Waiting until prices are already falling often leads to rushed decisions.
Key idea: The goal is not to predict the next crash. It is to learn whether your plan still works if one arrives at an inconvenient time.
Why a fire drill matters in retirement
Market drops affect savers in different ways depending on their stage of life. Someone decades from retirement can usually wait out a slump and may even buy more at lower prices. Someone who is retired or close to it may need to sell investments for living expenses while prices are down. Those losses can become permanent.
This risk is often called sequence-of-returns risk. Two retirees can earn the same average return over 20 years and still end up with very different results. The difference comes from when the bad years happen. Heavy losses in the first years of withdrawals tend to do the most damage.
How to run your own stress test
- Write down your current mix. List roughly how much you hold in stocks, bonds, and cash across all accounts.
- Pick a few bad scenarios. Use history as a guide. U.S. stocks fell more than 50% from peak to trough during the 2007–2009 financial crisis. In 2022, stocks and bonds both declined in the same year, so bonds did not cushion the drop as many people expected.
- Apply the losses. Multiply each part of your portfolio by its hypothetical decline and add up the new total.
- Compare against your spending. Work out what share of the smaller balance your planned withdrawals would represent.
- Check your gut. Picture seeing the lower number on your statement. Ask yourself honestly whether you would stick with your plan or be tempted to sell.
Example: putting numbers to it
This scenario is hypothetical and for illustration only. Imagine a $500,000 portfolio split 60% stocks and 40% bonds, with planned withdrawals of $25,000 a year.
Scenario A: stocks fall 30%, bonds hold steady
- Stocks: $300,000 drops to $210,000
- Bonds: stay at $200,000
- New total: $410,000, a decline of about 18%
- The $25,000 withdrawal rises from 5% of the portfolio to roughly 6.1%
Scenario B: stocks fall 25%, bonds fall 10%
- Stocks: $300,000 drops to $225,000
- Bonds: $200,000 drops to $180,000
- New total: $405,000, a decline of about 19%
- The $25,000 withdrawal now equals about 6.2% of the portfolio
In both scenarios, the overall loss is milder than the stock decline alone. Even so, the withdrawal rate rises noticeably. If the same spending continued through a long recovery, the portfolio would come under more strain.
What people commonly consider after a stress test
Your results might seem comfortable or worrying. Either way, here are some general approaches people often look into:
- A cash or short-term reserve. Some retirees keep one to two years of planned withdrawals in cash or similar holdings. That way they don't have to sell stocks during a downturn.
- Flexible spending rules. Deciding ahead of time to trim or skip discretionary spending after a bad year can reduce strain on the portfolio.
- Rebalancing on a schedule. Returning to a target mix at set intervals removes some of the emotion from the decision.
- Reviewing guaranteed income. Social Security timing, pensions, and other steady income sources affect how much a portfolio needs to supply.
- Getting a second opinion. A fee-only fiduciary advisor or a retirement planning tool can model more detailed scenarios than back-of-the-envelope math.
None of these is right for everyone. The best fit depends on your timeline, income needs, taxes, and comfort with risk.
Bottom line
A stress test turns a vague fear of the next crash into concrete numbers you can plan around. Run a few bad scenarios, see how your withdrawals would look against a smaller balance, and write down your response now. That preparation can make the difference between sticking with a plan and abandoning it at the worst moment. For the original coverage that inspired this explainer, see Money.com.
FAQ
How often should I stress test my portfolio?
Many people revisit it once a year. It also makes sense to repeat it after a major life change, such as retiring, receiving an inheritance, or changing your spending plans.
Does a stress test tell me how to invest?
No. It shows how a plan might behave under pressure. Deciding what to change depends on your personal situation, and you may want professional guidance for that.
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