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Having a firm grasp of your financial assets shouldn't stop at the other side of the ledger.

Having a firm grasp of your financial assets shouldn't stop at the other side of the ledger. 


A solid wealth management plan for wealthy families requires sound investment, risk management, estate planning and tax strategies, but ultimately its success rests on the ability to create and stick to a smart spending plan.


As with any flourishing business, individuals who successfully build and sustain wealth are strategic about their spending—but this doesn’t always come naturally, says Albert Trezza, vice president of advisory solutions at BNY Mellon Wealth Management. Too often, there’s a tendency to rely on rough mental accounting, which typically results in deep underestimates of spending, says Trezza, who runs analyses for wealthy clients to provide eye-opening scenarios about how small changes in spending trajectories can help to preserve wealth.


Consider the impact in a standard scenario of a 1 percentage point increase in spending for a family with a $20 million portfolio. Assuming average annual 5.25% portfolio growth, if the family spends 3% of assets every year, after two decades the portfolio’s value would be $30.3 million. In contrast, spending at a 4% rate would result in $24.6 million, or 18.7% less.


 “If spending is too high, even asset allocation becomes irrelevant,” Trezza says. “In the financial industry, you often hear it said that ‘asset allocation, as opposed to individual security selection, drives 90% of your returns.’ The spending decision trumps the asset allocation decision. To know whether your wealth is sustainable, you have to first understand what you spend.”


Experiences count, too


Simply estimating annual outlays is arguably more difficult than ever these days given the general move over the past decade (supported by U.S. consumer data) toward lifestyle and experiential spending—such as wellness and travel—at the expense of traditional designer goods. True, you’re unlikely to forget about a family vacation. But it’s easier to overlook how numerous intangible expenses, like twice-daily spin classes or college prep sessions (which may not even register as “spending”), add up compared to items such as a new luxury vehicle.


Tracking expenses requires a commitment by all members of the household. If they don’t see eye-to-eye on what’s reasonable and what’s excessive, the math is a motivator, Trezza says. Indeed, a single-page printout containing probabilities of success is usually enough to prompt agreement on spending limits.


He recently had to inform a couple they had a more than 60% chance of running out of money during their lifetimes given their spending habits. This simple but shocking data motivated the couple to consider ways to improve their outlook. Ultimately the couple committed to cutting spending by 25%—which nearly halved the odds to a more palatable 35% chance of outliving their wealth.


On the flip side, running the numbers sometimes gives extremely conservative spenders confidence to relax and live a little larger—maybe purchase a fly-fishing cabin in Wyoming or help a grandchild with a down payment on a first home.


Approach it like an institution might


It's important to be wary of shortcuts in determining appropriate spending levels, Trezza warns. There is a prevailing misconception that 4% is the magic spending level that will ensure assets won't be depleted over a lifetime, he says. But your age, changes in personal circumstances and market fluctuations may reveal that the right percentage is significantly different.


“The 4% rule for a 65-year-old may be OK, but it may be too high for someone in their 50s," he says. “If you're in your 70s, you may be able to spend 6% or 7%."


Institutional investors, such as defined benefit plans and non-profit endowments and foundations, always have a formal spending policy—specific guidelines that set a clear spending target while ensuring that the institution is still flexible enough to respond to changing circumstances and maintain a healthy cash flow. At BNY Mellon Wealth Management, the experts strive to bring these proven institutional strategies to individual investors, so they are able to be proactive with opportunities rather than reactive and can exert some control over their long-term financial outcome.


For individuals, says Trezza, a spending plan with a 70%-80% probability of success is generally a comfortable target, but as wealth levels vacillate with the markets and personal circumstances change, it’s important to regularly review the plan.


“The timing of market moves within a financial plan has a large impact,” he says. “In the event of a recession, we might see a client’s situation shift from a 75% chance of success to 60%. I recommend a check-in every year and a formal review every three years—or more frequently if there is a unique factor such as significant medical expenses or a large unplanned withdrawal.”


Keeping a spending plan on track can be a challenge—and that’s where an advisor can help. While there are natural fluctuations that shouldn’t cause alarm, such as higher spending in the first quarter due to the tax-filing season or at the end of the year for holiday getaways and gifts, “some people need the quarterly email saying, ‘Just so you know, you spent more this quarter than last year at this time,’” Trezza says. “Some clients might say, ‘It’s none of your business.’ But most people respond well to proactive outreach when it relates to a behavior they can control.”

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