Many people struggle with managing personal finances because as their net worth increases, financial decision-making becomes more complex. Although professional advice can help, most investors think that their financial counselors’ only job is to manage their investments. A good adviser, however, will look beyond a client’s assets and provide guidance on taxes, retirement, estate planning, insurance, and more. But how do investors measure the value they receive from broader financial counsel and not just on investments?
The potential benefits from “good” financial planning decisions can be hard to quantify. A recently released study from investment researcher Morningstar Inc. gives investors an idea of the added value of optimizing financial planning decisions – an extra 1.82 percent annually. Morningstar calls the measure “Gamma” (i.e. the third letter in the Greek alphabet) and defines it as “the extra income an investor can earn by making better financial decisions.”
Historically, investors have focused on choosing the “best” money-managers or mutual funds, the ones who “add value” which is the financial world’s way of saying they beat their benchmark consistently. The first two letters in the Greek alphabet (Alpha and Beta) are terms used to describe strategies that attempt to beat the market through specific stock selection and market timing. Numerous academic studies have consistently proven that the “beat the market” and speculative stock picking efforts are impressively and overwhelmingly negative.
Specific investments are less important than many of the other aspects in a client’s financial life and how they impact the portfolio-building decisions. Before the Morningstar study was released, it was challenging to determine the benefit someone receives for this kind of holistic advice with regard to its impact on overall financial well-being. Gamma confirms that there is much more a good adviser should offer other than helping someone pick good funds. The adviser should, rather, look at all aspects of a client’s financial life in order to provide context to the wealth.
In the research paper, Morningstar researchers zeroed in on five-key planning decisions:
-- Total wealth asset allocation.
-- Retirement withdrawal strategy.
-- Optimization of income streams (e.g. Social Security or pensions.)
-- Tax efficiency.
-- Liability or goal-driven investing.
From a holistic perspective, each of these Gamma concepts may be thought of as actions that need to be taken by an investor or financial planners on behalf of a client.
The most important “takeaway” from this study is that all aspects contributing to Gamma can be controlled by the investor or financial planner. To increase the probability of financial success, we recommend the following:
-- Portfolio asset allocation – The single most important decision you will make in investing. It’s critical to determine the right amount of risk in a portfolio and your financial and emotional ability to assume that risk in time to meet your goals.
-- Retirement withdrawal strategy – Managing a sustainable, tax-efficient portfolio withdrawal strategy in retirement is critical to long-term success.
-- Optimization of income streams – Pensions and Social Security are income streams from which you may benefit as a retiree. Inherent in these benefits are decisions that need to be made that will affect annual income for a lifetime.
-- Tax-efficiency – Smart tax investing and portfolio distribution strategies cannot be emphasized enough. Managing taxes is a component of investing that investors can control so it is important to continuously monitor the affects taxes and tax law changes have on portfolio returns and distributions.