How much additional retirement income can investors generate by making better financial planning decisions? Morningstar said today it has developed new research that can quantify that amount.
Morningstar officials say investors typically devote a considerable amount of time and effort to selecting investments and the managers to oversee them in an effort to outperform the market, what Morningstar calls the "alpha decision." Morningstar says "gamma" comes from making better financial planning choices. Morningstar researchers have created a series of portfolios and drawdown strategies that help investors achieve gamma. Using simulations, the researchers concluded a hypothetical retiree using a gamma strategy could generate approximately 29 percent more income -- or an annual arithmetic return increase of 1.82 percent -- compared with an average base-case strategy.
Morningstar's identified these five fundamental gamma strategies to improve financial planning decisions: Total Wealth Asset Allocation: Asset allocation often is based on an investor's aversion to risk. It should be based upon risk preference and risk capacity.
Dynamic Withdrawal Strategy: The annual withdrawal amount is based upon the ongoing likelihood of portfolio survivability and mortality experience.
Annuity Allocation: The contribution of an annuity based on its benefits, risk and costs should be considered before determining the appropriate amount of the annuity.
Asset Location And Source Of Withdrawals: It typically makes sense to withdraw money from taxable and tax-efficient accounts before tax-deferred or tax-free accounts.
Liability-Relative Optimization: Asset allocation methodologies commonly ignore the funding risks, like inflation and currency, associated with investor's goals. By incorporating the liability in the portfolio optimization process, it is possible to build portfolios that can better hedge the risks faced by a retiree.
Morningstar researchers say the most important of the strategies are applying a dynamic withdrawal strategyand making tax-efficient allocation decisions.