When I faced a major life decision of deciding whether or not to retire, looking at my financial situation was a big factor in the decision. I estimated what my future expenses would be and compared those against my expected income. I did a net worth statement, which forced me to total up my assets and liabilities. I even guesstimated how much I could pull from those savings and investments each year, and still have a good chance of having enough to live on until a very old age.
But I still wasn't satisfied. I needed something else to give me the confidence to make the leap. And then it dawned on me:
I needed to "stress test" each of my choices, by envisioning the worst-case scenario for each of the paths I was considering. If I decided that I could handle the worst outcome I could think of, then I figured it was OK to make that choice.
There's also a risk of being swayed by being overly optimistic about how well things could turn out. I forced myself to be realistic by envisioning a best-case scenario. But then I asked myself, what was the likelihood that things would turn out that way? That was another way of testing my decision.
The decision I faced was whether to retire. But the idea of "stress testing" would apply to any decision that has serious financial ramifications: having a child or a second child, buying your first home or a larger and more expensive home, or taking a pay cut to go back to school. And maybe we should stress test smaller decisions, too, like whether to buy a new car or maintain the old one, or whether to buy an extended warranty on a new TV.
Even if you're simply putting together a spending plan, with no major decisions looming, you would still do well to ask, “What could go wrong?” And, “How would I deal with that?” For example, how would you manage if you were faced with a large, unexpected expense, like a new roof on the house, a major car repair, or a layoff? “What could go wrong?” is great motivation for building up your emergency fund!
To be honest, I had more than one best- and worst-case scenario for staying at my job and for retiring. But for this post, I've boiled it down to just one. Here's how my little worksheet looked when I evaluated my best- and worst-case scenarios:
| Option | Best-case scenario | Likelihood | Worse-case scenario | Likelihood |
|---|---|---|---|---|
| Continue in my current job | A new position closer to my home will open up, and I'll be comfortable working several more years. | 15% |
My job is eliminated in 1-2 years, forcing me to retire at the worst time for my pension benefits. |
40% |
| Retire | I'll find a new job, closer to home or with a telecommuting option, at a comparable salary and flexible schedule. | 10% |
My husband gets laid off, and we've lost both incomes. |
50% |
Asking myself questions and completing the above table helped me to recognize that the likelihood of major, positive changes in my job were small. Facing the risk of my husband being laid off and evaluating our ability to manage financially if that happened, boosted my confidence in choosing option #2 - to retire.
Perhaps this approach will help you with a decision you're facing.
Written by Karen Chan, CFP, Consumer Economics Educator, University of Illinois Extension, 2014. Updated and modified by Kathy Sweedler, Illinois Extension, 2023.
Photo by Vladislav Babienko on Unsplash