Building a Resilient Financial Plan

This post continues from Stress-testing your financial plan. There, we used Monte-Carlo simulations to see how often sequence of return risks and other market variables can derail a best-laid plan built on predetermined and fixed assumptions of expected returns, interest rates, and the inflation rate.

In Ms. Nervous’s case we noted:

“With her current asset mix, there’s some risk of running out of money after age 80. But that’s far off, and there’s time to monitor and adjust.”

So how do we adjust—without permanently crimping lifestyle?

Guardrails (dynamic spending adjustments)

When returns disappoint, the simplest lever is spending. Cutting spending every year is blunt and joyless. A better approach is dynamic: ease off only after a poor return year, and relax again after strong years.

Even Warren Buffett has a playful, everyday version of this idea. In HBO’s "Becoming Warren Buffett", he explains that his McDonald’s breakfast choice depends on how the market is doing. He says his choices are $2.61 (two sausage patties), $2.95 (Sausage McMuffin with egg and cheese) or $3.17 (bacon, egg and cheese biscuit), and has his wife set up 3 cups with those exact amounts for him to choose from depending on the market performance.

“I tell my wife… ‘Either $2.61, $2.95 or $3.17.’ … But the market’s down this morning, so I’ll pass up the $3.17 and go with the $2.95.”

We apply the same principle at plan-scale. The MoneyReady App's guardrails work like this:

  • Run the baseline Monte-Carlo.

  • If success rate < 90%, rerun with a 10% spending reduction in any year following a year when portfolio returns fell below their expected return.

  • If still < 90%, step up to a 20% reduction; if needed, a 30% reduction.

This targets sequence risk when it actually shows up, rather than locking in permanent cuts.

It does require keeping an eye of the your portfolio results and how these compare to your known expected results.

SCANS (stress tests beyond markets)

Markets aren’t the only risk. The MoneyReady App SCANS let you sweep through scenario parameters (amounts, dates, linked life events) to see how robust your plan is.

We've created some pre-built canned scans that are commonly run to explore some of the common risk-factors you can try.

Although they are canned, you can modify their setup to change their default settings to your needs.

  • Longevity risk: This scan varies the date of death from when you are 85 years old to 110 years old. If there is a spouse, the scan will be for the death of the oldest spouse at those ages. The other spouse will then be set to die on the same date.

  • Survivorship risk: This scan varies the date of death of the youngest spouse for a number of years after the first one dies. This is used to assess life insurance needs.

  • Early retirement risk: Shift a retirement life event (age 40 to 65); all linked items follow.

  • Inflation risk: Inflation is part of the model we use in Monte Carlo simulations. However, you may just want to see the effect of varying only the inflation rate. This scan varies the inflation rate from 1% to 15%, and all your inputs linked to inflation will be affected. Because fixed-income rates of return are correlated with inflation, long-term expected return rates by asset class will be applied, and the fixed-income rate is set to the inflation rate -1%.

When the runs are finished, you will be able to see if any run leads to a cash-flow problem immediately, so you know when the parameter has been pushed too far.

Each scan produces a table of run stats (taxes, legacy, shortfalls, etc.). Any run is a full Time Machine report you can open and inspect.

These Canned scans are a great way to start exploring risks, and also show how to build your own scans on almost any parameter in your scenario. We include several examples in the Help and eBook for setting up sophisticated multi-parameter scans.

Scans aren’t only for risks—they’re also for possibilities: How much can I spend? How much should I save? When can I buy this house? When should I downsize? Scans are a powerful way to run and compare ranges without setting up each run individually, and you can run them on any amount or date for any entry.

You can always run a scan to get to a particular scenario you like, then run a Monte Carlo Simulation to make sure it works: it will apply guardrails automatically when necessary.

Your saved SCAN setups make it easy to rerun with fresh market values and updated scenario inputs.

The MoneyReady App puts powerful algorithms at your fingertips to build and explore a dynamic financial plan that adapts to whatever life and markets bring you.