Making Cents: Stress Test Your Forecast
By: John P. Napolitano, CFP®, CPA, PFS, MST
With an eye toward the dog days of summer vacation, this is a good time of year to think about how you would spend your time if every day was vacation. For many, the goal of not working some day is still alive. Retiring isn’t what it used to be, however. Today, retirees want a lifestyle that may be more active than their lifestyle while working and that scares them. Most are keenly aware that the lifestyle costs when you’re done working may be even higher than they were while you were working.
We’ve talked about forecasting before, and while it isn’t an exact science, it is the first step at assessing the consequences of working less and spending more. The forecast starts with your cost of living as you know it today. Be careful to not underestimate this amount. Your ultimate “proof” of the number is to look at the total amount that leaves your check book every month.
Next add the wish list items. Quantify the cost of your lifestyle while not working. To make this data a forecast, simply apply a net rate of return on assets and investments and choose an inflation rate to grow your cost of living. Fairly simple math, but there are many ways that forecasts get thrown off track.
The first way is to make incorrect assumptions. Just like our federal government now imposes stress tests on banks, you ought to perform a stress test on your personal financial well-being. Test your forecast with a higher rate of return and with a higher inflation rate. Do not wait for any of these possibilities to come true. It is best if you know in advance the consequences from your stress test activities should those situations arise during your lifetime.
Add in a few of life’s unpredictable obstacles. Matters like health care emergencies, loss of employment or a child who needs assistance will alter the most accurate forecast. For the health care part, stress test your forecast by factoring in the material cost of long term care insurance as well as the consequences of an uninsured long term illness. If the former looks ok, consider the purchase. If the cost of coverage makes your forecast look grim, consider alternative forms of protection including at home family care.
Recognize what you need from your assets. Many are walking around with a collection of investments and following the markets as if their life depended on it. Some have more risk than is needed and some are not taking enough risk to generate the needed rate of return. Construct a portfolio that will attempt to find as little volatility as possible within the confines of your desired rate of return.
Don’t forget taxes. With rates higher than in past years, take note of the location of your assets and the timing of your buys and sells. A little extra attention to tax matters should be beneficial in today’s world.
John P. Napolitano CFP®, CPA is CEO of US Wealth Management in Braintree, MA. Visit JohnPNapolitano on LinkedIn or uswealthnapolitano.com. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. John Napolitano is a registered principal with and securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through US Financial Advisors, a Registered Investment Advisor. US Financial Advisors and US Wealth Management are separate entities from LPL Financial. He can be reached at 781-849-9200.