Stress-Testing Portfolios

You may be familiar with the term “bank stress-test.” But do you know what it is? The 2008 financial crisis revealed bank’s vulnerability to market crashes and economic downturns which changed the way they think about risk.

A bank stress-test is required for banks with $50 billion or more in assets. It is an analysis conducted under hypothetical scenarios designed to determine whether a bank has enough capital to withstand a negative economic shock. The objective is to look at unfavorable situations, such as a deep recession or a financial market crash and determine the impact. Big banks are required to undergo internal stress- tests to check the health of their balance sheet based on credit risk, market risk and liquidity risk.

At Longevity Capital Management LLC, we feel all portfolios should be stress-tested for risk. That is why we continuously stress-test our client portfolios as a part of our ongoing portfolio management and monitoring. Our goal is to detect the potential of a given portfolio to withstand a major market upset or economic crisis. We feel this is important to exam in advance since such upsets tend to occur unexpectedly and without warning. We attempt to use hindsight to our advantage. The goal of stress-testing is to be able to strategically navigate through challenges without compromising your long-term financial independence.

We believe stress-testing (or crash-testing as it is sometimes called) can be an invaluable, forward looking analysis and yet we find it is often overlooked by individuals. How important is it to you to know how your portfolio may react should interest rates rise sharply or if there is a major economic crisis? Since a portfolio can be adversely impacted by interest rate changes, stock declines, sharp changes in commodities prices or even changes to geographic markets, such as the US, Europe, Japan or emerging markets, the goal for comprehensive portfolio management is not to only pursue opportunities, but also understand a portfolio’s weaknesses or vulnerabilities.

We know past performance is not a guarantee of future results and most investors understand there is uncertainty associated with investing, but do you really know how much risk your portfolio subjected to right now?  This is especially important to consider when managing your retirement savings, because it could be irrevocably damaged by substantial losses.

We feel it is critical to be prepared for these potential impacts by testing how your portfolio responds to various simulations. This may be especially valuable if you plan on transitioning to retirement soon. Since so few retirees these days have guaranteed retirement income other than Social Security, many of us are far more dependent upon our 401k, IRAs and personal savings than ever before.

How would a global stock crash, hyperinflation, economic meltdown, stagflation, oil shock or other calamity impact your retirement plan? If you want to know, we encourage you schedule a complimentary consultation to discuss our stress-testing process. For some, such a catastrophe could force a cut in income, compromise savings and/or result in financial hardship.

In case you haven’t noticed, the stock market has been booming. The S&P 500 Index has increased 237% in the past decade (as of 7/7/2021), and the NASDAQ has gained 432%. To put that in context, during the prior ten-year period (from July 2001-2011) the S&P 500 gained only +0.63% and the NASDAQ +25.25%, according to Morningstar Data (not including dividends).   

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