Better financial planning decisions can generate about 1.82% in annual added return for retirees, according to new research from Chicago-based, Morningstar, Inc.
In an effort to quantify the additional retirement income that investors can generate with better financial planning, a Morningstar research paper focuses on five fundamental financial planning decisions or techniques — optimal asset allocation based on total wealth; dynamic withdrawal strategy; product allocation (i.e., guaranteed income products versus traditional investment products); tax-efficient allocation and drawdown; and liability-driven investing. In the tradition of dividing returns into “alpha” and “beta”, they call the return generated by these decisions, “gamma”.
To isolate the possible gamma return, they created a series of portfolios and drawdown strategies that employ these techniques, along with a base case scenario drawn from the practices of average U.S. investors. And, through a series of simulations, they found that a hypothetical retiree may generate approximately 29% more income using an efficient retirement income strategy, which is equivalent to an annual arithmetic return increase of 1.82%, compared with the average base case strategy.
They also found that using a dynamic withdrawal strategy — determining the annual withdrawal amount annually based on the ongoing likelihood of portfolio survivability and mortality experience —was most important, followed by making tax-efficient allocation decisions.
“Investors arguably put a lot of time and effort into selecting investment funds or managers they hope will outperform the market—the so called ‘alpha’ decision. However, alpha is just one of many important decisions that can have a significant effect on retirement income,” said David Blanchett, head of retirement research for the Morningstar Investment Management division. “Unlike traditional alpha, which can be hard to predict, any investor can achieve gamma by following an efficient financial planning strategy.”