Models of Restraint
The computing power available today allows many private banks and wealth advisors to create tailor-made models to help manage spending and other liabilities, as well as assets. "We start on the spending side and work toward the asset allocation," says Joe Leone, wealth manager with Chatham, N.J.-based RegentAtlantic Capital.

"More often than not, as people acquire more wealth they are not in fact richer, because their spending goes up more than their wealth has."

A typical model, for example, would take into account income, returns on existing investments and average annual outflows. Some sophisticated mathematical modeling can determine, with a certain probability, the chances of experiencing a serious loss of wealth within a certain time period, given the historical performance of various investment markets. "Once we determine the spending level versus income and investment returns equation, then we can pick an asset allocation that provides a way to meet those spending goals with the least amount of risk," Leone explains.

"We do extensive modeling on spending," explains Daniel Dunn, a New York—based wealth advisor with the Merrill Lynch Private Banking and Investment Group. "Our software uses over 1,000 different modeling simulations to give the client a probability, based on the current asset allocation, of what the chances are that he will keep his net worth intact."

The most difficult part of the process, Leone says, is actually sitting down to work out how much an individual spends. "Sometimes that exercise is difficult for the client, but also enlightening," he explains. "The second hurdle is, if we recommend putting restraints on spending, we must determine where [to place those restraints]. We re-run the model every couple of years and factor in any changes to their income, expenses or goals, and that way we try to encourage them to stick to it."

Perhaps the biggest challenge for any affluent individual is considering the prospect that he is spending too much. It may come as a shock to a family with a $100 million portfolio that it can only safely spend $3 million to $4 million a year–on consumption, gifts, philanthropic endeavors and lifestyle–without eroding the value of that portfolio. Advisors often find this is a difficult truth for their clients to face. "That is not an easy conversation to have," Stewart says.

Most advisors will recommend only spending a fixed percentage of a static pool of funds per year, which means when markets go down, investors automatically reduce spending to cushion the blow. However, few individuals look at their spending patterns in this manner; most want to maintain the same lifestyle from year to year. "The reality is that individuals spend dollars, they don’t spend percentages," Stewart says. "But I think you have to at least be conscious of what that fixed dollar amount represents as a percentage of your portfolio, because if it creeps up, then you may have to reevaluate what you're doing."