Scenario Planning for Best, Base, and Worst Cases
Financial planning requires acknowledging uncertainty. Markets fluctuate, employment situations change, and health events occur without warning. Rather than creating a single projection that assumes everything proceeds as expected, sophisticated planning models multiple scenarios to stress-test your financial resilience. This guide explains how to construct base, best, and worst-case scenarios, interpret Monte Carlo simulation results, and develop contingency triggers that protect your financial security.
The Three-Scenario Framework
Base Case: Expected Trajectory
The base case represents your most likely outcome given reasonable assumptions about returns, spending, and life circumstances.
Base Case Assumptions:
- Investment returns: Long-term historical averages adjusted for current valuations
- Inflation: 2.5% annually (Federal Reserve target with buffer)
- Spending: Current lifestyle maintained, adjusted for inflation
- Income: Continued employment at current trajectory
- Retirement: Planned age (often 65–67)
- Social Security: Claiming at full retirement age
- Health: Standard aging assumptions, Medicare at 65
Setting Return Expectations:
Historical returns provide context, but forward-looking estimates should account for current conditions.
| Asset Class | Historical (1926–2024) | Current Forward Estimate |
|---|---|---|
| US Large Cap | 10.3% nominal | 6.5–7.5% nominal |
| US Small Cap | 11.9% nominal | 7.0–8.5% nominal |
| International Developed | 8.1% nominal | 6.0–7.0% nominal |
| US Aggregate Bonds | 5.2% nominal | 4.0–5.0% nominal |
| 60/40 Portfolio | 8.5% nominal | 5.5–6.5% nominal |
Lower forward estimates reflect elevated equity valuations and normalized interest rates compared to the 40-year bond bull market.
Best Case: Favorable Conditions
The best case models outcomes when multiple factors align positively, allowing for accelerated goal achievement or enhanced lifestyle.
Best Case Assumption Adjustments:
| Factor | Base Case | Best Case |
|---|---|---|
| Investment returns | 6% real | 8% real |
| Spending growth | Inflation (2.5%) | Below inflation (1.5%) |
| Income growth | 2% real | 4% real |
| Retirement age | 65 | 62 |
| Health costs | Average | Below average |
| Windfalls | None | Inheritance or bonus |
Best Case Uses:
- Identify early retirement feasibility
- Quantify "upside" potential for motivation
- Determine when to increase charitable giving
- Evaluate lifestyle enhancement options
Worst Case: Stress Testing
The worst case models adverse conditions to identify vulnerabilities and necessary contingencies.
Worst Case Assumption Adjustments:
| Factor | Base Case | Worst Case |
|---|---|---|
| Investment returns | 6% real | 2% real (or sequence of returns risk) |
| Market decline | None | -40% in year 1 of retirement |
| Spending | Planned | 120% of planned (health events) |
| Income | Continued | Job loss at age 55, 12-month gap |
| Retirement age | 65 | 65 (cannot delay) |
| Social Security | Full | 77% (trust fund depletion adjustment) |
| Long-term care | None | 3-year facility stay |
Key Stress Events to Model:
- Sequence of Returns Risk: Major market decline in early retirement years
- Involuntary Early Retirement: Job loss or health issue forcing early exit from workforce
- Healthcare Shock: Major illness requiring extended treatment or long-term care
- Longevity Risk: Living to 95+ with portfolio depletion concerns
- Inflation Spike: Sustained 5%+ inflation eroding purchasing power
Monte Carlo Simulation Interpretation
How Monte Carlo Works
Monte Carlo simulation runs thousands of randomized scenarios, varying investment returns according to historical patterns or specified distributions. Each trial produces a different sequence of returns, allowing the model to estimate the probability of achieving various outcomes.
Key Inputs:
- Starting portfolio value
- Annual contributions or withdrawals
- Asset allocation and associated return/volatility assumptions
- Time horizon
- Target ending value or income stream
Output:
- Probability of success (reaching target or not depleting assets)
- Distribution of ending values (median, 10th percentile, 90th percentile)
- Year-by-year confidence intervals
Interpreting Success Rates
| Success Rate | Interpretation | Recommended Action |
|---|---|---|
| 95%+ | Very high confidence, potentially overfunded | Consider increasing spending or earlier retirement |
| 85–95% | High confidence, on track | Maintain current plan |
| 75–85% | Good confidence with flexibility required | Build contingency triggers |
| 65–75% | Moderate confidence, adjustments likely needed | Identify specific adjustments now |
| Below 65% | Low confidence, plan changes required | Increase savings, delay retirement, or reduce spending |
Important Considerations:
- Monte Carlo success rates are estimates, not guarantees
- Historical return sequences may not predict future patterns
- Input assumptions significantly affect outputs
- Success rates near 100% may indicate excessive conservatism
- Most planners target 75–90% success, allowing for flexibility
Percentile Analysis
Rather than focusing solely on probability of success, examine the distribution of outcomes.
Example Output:
| Percentile | Ending Portfolio Value | Interpretation |
|---|---|---|
| 90th | $3,200,000 | Excellent outcome, 10% chance of exceeding |
| 75th | $2,400,000 | Good outcome |
| 50th (Median) | $1,650,000 | Most likely single outcome |
| 25th | $980,000 | Below average but acceptable |
| 10th | $420,000 | Poor outcome, 10% chance of worse |
| 5th | $180,000 | Very poor outcome, approaching depletion |
The spread between percentiles indicates volatility of outcomes. Wider spreads suggest higher-risk portfolios or longer time horizons.
Worked Example: Retirement Projections Under Three Scenarios
Client Profile:
- Margaret (58) and David (56)
- Combined income: $245,000
- Current portfolio: $1,850,000
- Annual savings: $65,000 (until retirement)
- Planned retirement: Margaret at 65, David at 65
- Target annual spending: $130,000 (today's dollars)
- Social Security (combined at 67): $68,000
- Required portfolio withdrawal: $62,000/year at retirement (inflation-adjusted)
Base Case Projection
Assumptions:
- Investment return: 5.5% nominal (3% real after 2.5% inflation)
- Retirement age: Margaret 65, David 65 (7 years)
- Spending: $130,000 inflation-adjusted
- Social Security: Claimed at 67
Projection:
| Year | Age (M/D) | Portfolio Start | Contributions | Growth (5.5%) | Withdrawals | Year End |
|---|---|---|---|---|---|---|
| 1 | 58/56 | $1,850,000 | $65,000 | $105,325 | $0 | $2,020,325 |
| 3 | 60/58 | $2,207,000 | $65,000 | $124,960 | $0 | $2,396,960 |
| 5 | 62/60 | $2,619,000 | $65,000 | $147,545 | $0 | $2,831,545 |
| 7 | 64/62 | $3,091,000 | $65,000 | $173,545 | $0 | $3,329,545 |
| 8 | 65/63 | $3,329,545 | $0 | $183,125 | $133,575 | $3,379,095 |
| 10 | 67/65 | $3,470,000 | $0 | $190,850 | $140,540 | $3,520,310 |
Note: Social Security begins year 10 ($68,000), reducing portfolio withdrawals to $72,540.
| Year | Age (M/D) | Withdrawal | SS Income | Portfolio Balance |
|---|---|---|---|---|
| 15 | 72/70 | $83,250 | $76,500 | $3,180,000 |
| 20 | 77/75 | $93,800 | $86,200 | $2,690,000 |
| 25 | 82/80 | $105,700 | $97,100 | $2,020,000 |
| 30 | 87/85 | $119,100 | $109,400 | $1,180,000 |
| 35 | 92/90 | $134,200 | $123,200 | $140,000 |
Base Case Result: Portfolio sustains withdrawals to approximately age 93/91. Monte Carlo success rate: 82%.
Best Case Projection
Assumption Adjustments:
- Investment return: 7.5% nominal (5% real)
- Spending: Grows at 2% (below 2.5% inflation)
- Retirement: Margaret at 63, David at 63 (5 years)
- Both delay Social Security to 70 for 24% increase
Key Milestones:
| Milestone | Best Case | Base Case |
|---|---|---|
| Portfolio at retirement | $2,831,000 | $3,329,000 |
| Retirement age | 63/61 | 65/63 |
| Social Security annual | $84,300 (delayed) | $68,000 |
| Portfolio at age 85 | $2,850,000 | $1,180,000 |
| Monte Carlo success rate | 96% | 82% |
Best Case Opportunities:
- Early retirement at 63 feasible with 90%+ success rate
- Potential to increase spending to $145,000 with 85% success
- Legacy portfolio of $2M+ likely at life expectancy
- Charitable giving capacity of $30,000/year without affecting security
Worst Case Projection
Stress Scenario 1: Market Crash at Retirement
Assumptions:
- 40% market decline in year 1 of retirement (year 8)
- Returns normalize to 5.5% thereafter
| Year | Event | Portfolio Impact |
|---|---|---|
| 7 | End of accumulation | $3,329,000 |
| 8 | -40% decline + withdrawal | $1,864,000 |
| 9 | 5.5% recovery + withdrawal | $1,828,000 |
| 10 | SS begins, reduced withdrawal | $1,850,000 |
Recovery trajectory shows portfolio stabilizing but remaining $1.5M below base case for 15+ years.
Monte Carlo success rate with sequence risk stress: 68%
Stress Scenario 2: David Job Loss at 60
Assumptions:
- David loses job at age 60, 18-month unemployment
- Income drops from $245,000 to $140,000 for 18 months
- Retirement savings pause during unemployment
- Portfolio withdrawal of $50,000 to cover income gap
Impact:
- Portfolio reduced by $130,000 (lost contributions + withdrawal)
- Retirement delayed to age 67 for both
- Monte Carlo success rate: 74%
Stress Scenario 3: Long-Term Care Event
Assumptions:
- David requires memory care at age 80
- Cost: $8,500/month for 4 years = $408,000 total
- No long-term care insurance
Impact:
- Additional $408,000 withdrawn from portfolio ages 80–84
- Portfolio depletes at age 88/86 instead of 93/91
- Monte Carlo success rate: 61%
Scenario Comparison Summary
| Metric | Best Case | Base Case | Worst Case (Combined) |
|---|---|---|---|
| Retirement age | 63/61 | 65/63 | 67/65 |
| Starting retirement portfolio | $2,831,000 | $3,329,000 | $2,800,000 |
| Annual spending supported | $145,000 | $130,000 | $115,000 |
| Portfolio at age 85 | $2,850,000 | $1,180,000 | Depleted |
| Monte Carlo success rate | 96% | 82% | 58% |
Building Contingency Plans
Contingency Triggers
Establish specific thresholds that activate contingency responses:
| Trigger | Threshold | Contingency Response |
|---|---|---|
| Portfolio decline | -25% from peak | Reduce spending by 10% for 2 years |
| Portfolio decline | -35% from peak | Reduce spending by 20%, defer discretionary expenses |
| Monte Carlo success | Falls below 70% | Implement spending reduction or income generation |
| Withdrawal rate | Exceeds 5.5% | Reduce spending to sustainable level |
| Healthcare costs | Exceed budget by 50% | Activate long-term care plan, evaluate downsizing |
Spending Flexibility Analysis
Identify discretionary vs. essential spending to understand flexibility:
| Category | Annual Amount | Classification | Reducibility |
|---|---|---|---|
| Housing (mortgage/taxes) | $28,000 | Essential | Low (unless downsize) |
| Healthcare | $18,000 | Essential | Low |
| Food and household | $15,000 | Essential | Moderate (10–20%) |
| Transportation | $12,000 | Essential | Moderate (one car option) |
| Utilities and insurance | $8,000 | Essential | Low |
| Travel | $20,000 | Discretionary | High (50–100%) |
| Entertainment/dining | $12,000 | Discretionary | High (50–75%) |
| Gifts and charity | $10,000 | Discretionary | High (50–100%) |
| Miscellaneous | $7,000 | Mixed | Moderate (25–50%) |
| Total | $130,000 | ||
| Essential spending | $81,000 | ||
| Discretionary spending | $49,000 |
Spending could reduce to $85,000–$95,000 if necessary, providing significant buffer against adverse scenarios.
Sample Review Cadence for Scenario Planning
| Frequency | Activity |
|---|---|
| Annually | Full three-scenario review with updated assumptions |
| Quarterly | Portfolio performance vs. projections |
| Market decline >15% | Ad-hoc scenario stress test |
| Major life event | Immediate scenario recalculation |
| Every 3 years | Comprehensive assumption review and reset |
Scenario Planning Checklist
Base Case Development
- Document current return assumptions with sources
- Specify inflation assumption (typically 2.5–3%)
- Confirm spending reflects actual current lifestyle
- Include all income sources with start dates
- Model Social Security with personalized estimates
- Run Monte Carlo with 1,000+ trials
Best Case Analysis
- Increase return assumptions by 1.5–2% above base
- Model spending growth below inflation
- Evaluate early retirement feasibility
- Identify wealth threshold for lifestyle enhancements
- Calculate charitable giving capacity
- Document opportunities unlocked by favorable outcomes
Worst Case Stress Testing
- Model 40% market decline in first retirement year
- Stress test job loss scenario (12–24 month unemployment)
- Include healthcare shock ($200,000–$500,000 event)
- Model long-term care scenario (3–5 years of care)
- Test Social Security reduction to 77% of projected
- Calculate minimum portfolio needed for essential spending
Contingency Planning
- Establish portfolio decline triggers with specific responses
- Document spending reduction capacity (discretionary vs. essential)
- Identify potential income generation options
- Evaluate home equity as emergency reserve
- Review long-term care insurance options
- Create decision tree for major stress events
Ongoing Monitoring
- Track portfolio against scenario projections quarterly
- Update Monte Carlo inputs annually
- Recalculate scenarios after major market moves
- Adjust assumptions when economic conditions shift
- Review contingency triggers after each annual update
- Document all assumption changes with rationale