What would you do to create an extra 1.8% return in your investment portfolio?

Well, according to recent research by Morningstar, receiving some quality Financial Planning advice ought to do it.

Until now the value of a good Financial Planner has been largely intangible leaving some investors questioning whether any fee is “worth it”. Thanks to this new research, from Morningstar Inc., investors now have a quantified figure on how much additional retirement income investors can generate through a more intelligently thought out investment strategy.

While most investors are familiar with the term Alpha (above market returns achieved by way of manager skill) and Beta (returns generated by the market), the paper introduces a new investor term, namely Gamma. Gamma, as defined by Morningstar, is “the extra income an investor can earn by making better financial decisions,” and therefore begins to highlight what to expect when working with a professional Financial Planner.

The research found that delivery of the “Gamma” return was relatively predictable provided certain steps were observed. This is unlike Alpha, where beating the market is unpredictable and an unreliable strategy to focus solely on. In establishing their findings, 5 areas were key in providing the excess return. They were:

  • Total Assest Allocation
  • Withdrawal Strategy
  • Tax efficiency (Tax can be seen as investor enemy number 2 with inflation as the main villain) Use of guaranteed annuities
  • Liability driven investing(also broadly known as asset to liability matching)

The first three elements accounted for over 85% of the outcome whilst the last less than 15% and hence we will focus on the first three.

 


Asset Allocation

The process of constructing the right mix of assets (equities, property, bonds and cash) both locally and offshore is vital in driving your investment objectives. A well-known study by Brinson, Hood and Beebower (also mentioned in the Morningstar paper) suggests that 94% of the return driver within a portfolio is attributed to asset allocation. The other 6% is due to stock picking and market timing.

It is therefore easy to see how important this aspect of your portfolio is. Of course, the most reliable way of establishing what your return objective should be and how hard your money needs to work is through sound Financial Planning. Once a plan is in place, the return target can be set and assets allocated accordingly. From there the all-important role of rebalanecing needs to begin to ensure an appropriate mix of assets is maintained despite market movements.

Withdrawal Strategy

The study does deal predominantly on post-retirement investing and therefore the focus on where and how one draws and income from their investment portfolio. In many regard, it ties into the third aspect of tax efficiency.

Most investors will have compulsory funds such as pension and R.A’s, as well as discretionary money such as Collective Investments (Unit Trusts), share portfolios and cash holdings. Because each of these have different tax consequences, splitting out your withdrawals intelligently can bring down overall tax whilst carefully monitoring that capital balances are not depleted unnecessarily. The CFP® , CERTIFIED FINANCIAL PLANNER® and are trademarks owned outside the U.S. by Financial Planning Standards Board Ltd (FPSB). FPI is the marks licensing authority for the CFP® Marks in South Africa through agreement with FPSB.

Tax Efficiency

As briefly mentioned above, one of the key differences between the various investment platforms and products is that of tax. The legislation treats them differently in terms of what contributions you make into an investment, how it will be taxed whilst invested as well as how you will be taxed on any withdrawals taken.

With the recent tax changes that took place, specifically, Capital Gains Tax (CGT) and Dividend Withholding Tax (DWT), managing tax within your portfolio has become even more important. Although certain elements of our tax legislation has become burdensome on investments, few investors take advantage of the many tax deductions, exclusions and exemptions that are freely available and in the process leave a “tax drag” on the performance of their portfolio.

 


Morningstar’s researchers found that a hypothetical retiree could generate nearly 30 percent ‘more income using a Gamma-efficient retirement-income strategy.

David Blanchett, co-author had the following conclusion: “There’s significant benefit for retirees or investors in general to having someone make the right decisions. Gamma is something that everyone can do that adds the most value; we call them financial planners or advisers, we don’t call them mutual fund pickers. …It really is worth it to pay someone 1 percent a year to help me figure out how to do this stuff because (the 1.8 percent) is significant value that any (adviser) can achieve.” The article was written for and first published in Wealthwise Magazine, February 2013. It is now available on .