You know about alpha and beta, but you should know about gamma, which provides advisors with the foundation to help their clients generate more retirement income
In an environment of low yields and higher taxes, as ongoing volatility remains a factor and Americans live longer, advisors must manage multiple challenges to help their clients generate lasting retirement income.
Traditionally, fixed income has been the core of most retirees’ portfolios. After the financial crisis, many Americans saw it as a safe haven from the volatile stock market. But in today’s low yield environment, advisors cannot rely on fixed income alone to meet their client’s income needs.
To help improve clients’ chances of generating more income for more years, many advisors seek to maintain a significantly higher allocation of equities in clients’ retirement income portfolios. But a higher allocation to equities comes with higher risks, making proactive strategies for risk management an increasing imperative.
Research shows that most Americans still need to accumulate more assets to generate sufficient income in retirement, and outliving their assets in retirement has become their number one concern. Studies also indicate that even high-net-worth investors face serious risks to their retirement income—including rising healthcare costs, the threat of inflation and the impact of prolonged periods of increased tax rates on their investments.
Facing this triple threat of a low yield environment, maintaining adequate equity exposure and managing volatility, advisors are turning to tax-optimized tactics to increase Gamma. According to Jefferson National’s latest survey of over 400 advisors, 85% say tax deferral is one of the most important solutions to maximize accumulation and generate more retirement income.
What Is Gamma?
The concepts of Alpha and Beta are well known and regularly used by financial advisors to discuss investment strategies with their clients. However, these are not the sole factors that produce more retirement income.
Last year, David Blanchett and Paul Kaplan of Morningstar introduced an intriguing new approach to measuring Gamma in their published research, “Alpha, Beta, and Now…Gamma.” This new approach to Gamma was developed “to quantify the additional value that can be achieved by an individual investor from making more intelligent financial planning decisions.” According to the research, Gamma, when used in the context of generating more retirement income, is created from five factors:
1) asset location and withdrawal sourcing
2) total wealth asset allocation
3) annuity allocation
4) dynamic withdrawal strategy
5) liability-relative optimization.
As clients are primarily concerned with outliving their retirement savings, we believe Gamma helps fill a gap in the discussion that advisors are having with their clients about their investment decisions.
While all five factors play an important part to achieve Gamma and generate more retirement income, the factor of tax-optimized investing through asset location and withdrawal sourcing is becoming increasingly important for advisors and their clients, especially HNW clients who experience the highest burden when taxes rise. According to the research, there is measurable value in the asset location component of Gamma, which may add as much as 320 basis points (bps) of additional retirement income to client portfolios every year.
As advisors work with their clients to maximize their investment performance while ensuring income in their Golden Years, boosting Gamma through tax-advantaged investing should be a key strategy. Specifically, advisors can look to a concept known as the “Tax-Efficient Frontier,” which is simply locating assets based on their tax treatment to increase returns—without increasing risk. In fact, 88% of advisors surveyed leverage tax deferral by using asset location to help minimize the impact of taxes and enhance after-tax returns.
Optimizing Portfolios Through Asset Location