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Intelligent Advisor

Going for "gamma"

Want to prove your worth to clients? Demonstrate your mastery of “gamma.”

Alpha is the metric of risk-adjusted return, and beta is the metric of correlation, but Morningstar’s head of retirement research David Blanchett suggests advisors can add almost as much as an extra 2% annually to a client’s return by something he calls “gamma,” how he defines the “benefits of good financial planning.”

Consider the common rule of thumb that retirees should withdrawal some 4% of their portfolio annually per year. Clearly this is too simplistic for most, but finding the right balance is one of the trickier, if not the trickiest, part of financial planning. Too much too early, there is a danger of running out of money. Not enough and clients risk dying with a bucket of money that could have been spent.

Not to mention that the 4% rule requires a cooperative market. Blanchett pointed out that in todays conditions, with a shiller P/E ration of around 25, and interest rates around 2%, the 4% rule only has a 40% chance of succeeding in adequately funding an average retirement.

While getting the right portfolio withdrawal strategy is complicated, Blanchett suggested one way advisors might approach it is to reconsider their reluctance to use annuities. “It’s the only way to create guaranteed income.” But advisors need to think of annuities as insurance, not an investment, and nobody should expect a positive value from insurance. You’re trading wealth for certitude.

Another way to generate gamma, suggest Blanchett, is simply ensuring investments are not simply divided between taxable and tax-efficient accounts, but rather in the accounts most suitable. For instance, everyone knows bonds, with some exceptions, belong in tax-efficient accounts simply because the cash they throw off is taxed at the higher personal income rate. $100 held in bonds over 25 years grows to $222 when held in a taxable account, Blanchett says (assuming a 35% personal tax rate). In a tax-free account, that grows to $255. Drawing down accounts in a tax efficient method (usually from taxable accounts first while allowing tax-deferred to grow as long as possible) also leads to gamma. It’s also a rare individual that doesn’t benefit from delaying social security to get the bigger monthly payouts, Blanchett says.

Doing all of this with maximum efficiency, Blanchett suggest, can boost a retiree’s income by 29%, according to his simulations. Of course, getting the equation exactly right is impossible, but advisors should strive to get close. “Retirement planning, hands down, is the most difficult task advisors face. Clients need help. It costs money, but the money is worth it.”

Mention that the next time clients question your value.


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