Have you ever seen the crash test commercials on TV where a car is hurled into a wall and the test dummy is violently thrown around? Did the airbag deploy? Did the front end collapse like an accordion to absorb the impact? Was the test dummy unscathed?
Those crash test dummies just went through a stress test. The concept of stress testing is likely familiar to anyone with an engineering background. When new products are developed or old products are revised, engineers are often tasked with ensuring the end product will perform within the specifications. They’re put through an intentionally intense test—and often pushed to a breaking point—to see how stable the product is and whether it can meet certain standards.
We recommend that you put your financial plan through a stress test on a periodic basis, just to make sure it’s living up to your needs. Here’s how to perform that periodic check—and improve your finances in the process!
Evaluate Your Changing Needs
Your financial picture is going to constantly change throughout your life. Your needs will change; your goals will change. As it does, you’re going to want to check your financial plan to make sure you’re still on track. Consider what needs to be added; see what needs have expired and need to be removed. Before you enter the stress testing phase, you should do a preliminary tune-up and revisit your financial picture to make sure it’s still working for you.
There are four primary areas that you should pay attention to during your stress test: investment, insurance, debt, and taxes. These four topics may seem dissimilar, but, when handled well, all of them can still be viewed as investment strategies. Insurance can help build your estate; smart tax maneuvers can help protect and build your investments; taking out loans at the right time, for the right reason can help build your equity; and making smart tax decisions can result in great rates of return.
Alternately, all of them can drain your estate if you’re not mindful about your approach. Many of these topics can be complex, which is one reason why you might find it helpful to work with a team of professionals, not only to evaluate your current scenario for gaps and issues, but also for opportunities and ensuring you are building the best financial life possible.
Let the Testing Begin
Stress testing is the best way to evaluate possible scenarios that may impact those four areas, and the actual method is quite simple: run a set of “what-if” scenarios and see how your financial plan measures up. For instance, what would your financial picture look like if you retired at age 62, rather than at age 65? Or, how would your financial picture change if you decide to buy a vacation home?
These sorts of hypothetical questions come up all the time when people are making big decisions related to investments, insurance, debt, and taxes—which makes stress testing an especially valuable step in your decision-making process.
Think about your own life. It’s likely you can track many different stages and phases that have occurred over time as your family and financial dynamics shifted. Some of these stages are obvious, like retirement, marriage, or having a child. However, other stages are less predictable, like the timing of an inheritance or an illness.
In any case, when a major event or life change occurs, your current plan can become obsolete. Ask yourself: does your current plan account for the most recent changes and your desire for the future?
If you come up with a scenario that falls short, or you find gaps in your plan, then you’ll be able to come up with a plan to address them, much in the same way that if a car performs poorly in a crash test, engineers head back to the drawing board with more information to help them solve the problem.
The process used for stress testing should be designed to focus on addressing any gaps or opportunities in the following key areas:
● Tax Efficiency: Are my distributions, investment holdings, estate plan, types of accounts, etc., optimized for my specific situation and current circumstances?
● Wealth Transfer: Will my assets go where I want them to if something were to happen to me? Who will control the assets? Have my wishes changed since originally establishing?
● Charitable Impact: Based on current laws and my personal desires, am I employing the best strategy for charitable giving?
In other words, stress testing helps you evaluate whether or not your current financial strategies and products are accomplishing your family’s key goals and objectives. The process helps you identify opportunities that you may have overlooked which could improve your outcome.
Find the Best Route
By going through the process of stress testing, you’re able to look at many of the “what-ifs” of your future and consider the range of possible outcomes for each possible scenario so that you can ideally aim yourself toward the best one.
Think of it as standing at the intersection of your financial and emotional decisions and determining the best route possible to effectively accomplish your goals. Stress testing will help you optimize your financial picture in each of the major financial areas in your life and come up with a financial plan that meets your needs at every step of the way.
For more advice on stress testing your finances, you can find Pass It On on Amazon.
Roger and Lori Gervais are proud parents of three wonderful children: Anna, Will, and Jack. Roger and Lori are also the husband-and-wife team behind The Gervais Group, named by Forbes as “Best in State Wealth Advisors” in Wisconsin. Lori, a CERTIFIED FINANCIAL PLANNER™ professional, has been recognized for her commitment to clients and to the profession by Forbes, which named her to its America’s Top Women Advisor List. Roger, a CFA® charterholder, uses his background in engineering to offer clients a unique set of problem-solving skills. Throughout their thirty years of combined experience in the industry, Roger and Lori have made it their mission to simplify the complex world of financial planning.