This does not mean real-world gamma would be lower necessarily. The 4 percent rule assumes a spending and an investment discipline few individuals have, for instance. One could argue that a real-world gamma would be one that compares not to the 4 percent rule but to what the client would do without the advice of a planner. As discussed in my last column, making a meaningful comparison to what another person would do is full of conjecture and extremely difficult.
I think it reasonable to take a few things out of this study that can be applied to the real world. The gamma factor that added the most was the dynamic withdrawal strategy, and the assumptions that went into the testing were the most duplicable when working with clients.
Planners can run similar simulations that determine a failure rate, incorporate a mortality assumption, and adjust withdrawals when certain parameters are exceeded. The gamma factor with the second-largest impact, asset location and tax efficient withdrawals, also could be implemented as easily.
Most good planners incorporate these ideas today. This is not unexpected, given one purpose of the study was to quantify how helpful the techniques used by planners actual are.
I found the least real-world usefulness with two of the other three gamma factors. The liability relative optimization makes theoretical sense, but I was disappointed to see the minimal impact from using it. The annuity allocation, while a plus, didn’t add enough to entice people to overcome their aversion to annuitization.
The most challenging part of the study is the explanation of how gamma is measured. I am not disputing its validity, just pointing out that it is difficult to follow. You will need a grasp of utility functions. I live on the Space Coast of Florida and am surrounded by real rocket scientists, and my guess is less than 1 percent would understand the calculation. So if you want to get into this with a client, you may come out looking smart or you could just confuse them. I have yet to share the study with clients.
The more practical use of this study for practitioners is that it gives us a little more confidence that dynamic withdrawal strategies and tax management are worth implementing. That alone is valuable to me and I’m looking forward to future research on gamma.
Dan Moisand, CFP, has been featured as one of the America’s top independent financial advisors by most leading financial advisor publications. He has spoken to advisor groups on five continents on topics such as managing investments and navigating tax complexities for retirees, retirement readiness, and topics relating to the development of the financial planning profession. He practices in Melbourne, Fla. You can reach him at [email protected].