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Proving the Value of Financial Planning

By Martin Iglesias, CFP

We all know the importance of personal financial planning, however there has always been a difficulty to quantify its real value. When a client wants to know if it is worth hiring a financial planner, it is difficult to show them quantitative proof.

Luckily, Morningstar recently published a study that estimated the value which would be generated by the process of personal financial planning. In the study, the authors have dubbed the value of financial planning, with a very interesting name: gamma.

Gamma is added to two established concepts in the management of investments, alpha and beta; alpha being linked to the excess of returns generated by the quality of asset management and beta being linked to strategic asset allocation decisions.

Alpha, Beta, and Gamma

The most interesting point is that alpha is very difficult to generate and advocates of the hypothesis of efficiency market say that it is, on average, equal to zero. Beta basically depends on risk preferences and the return of the portfolio is generated by the level of risk assumed. The gain generated by gamma is very clear and supported by techniques and knowledge that can be acquired through study, discussion and mainly by experience, all within our scope of work, personal finance.

The study focused on generating value in the period of retirement and rescue support in five major areas:

  1. Total Asset Allocation Wealth: Allocation is not made by mean-variance models such as the CAPM but using both human capital and financial capital, as suggested by theory life cycle.
  2. Dynamic Withdrawal Strategy: considers withdrawals not a fixed percentage of assets, but driven by life expectancy of the investor and its variation over time.
  3. Allocation Annuity: tries to reduce the risk that resources will not be enough during retirement.
  4. Asset Allocation and Withdrawal Sourcing: considers tax efficiency
  5. Liability- Relative Optimization: takes into account the goals and liabilities linked to the consumption pattern of the customer.

Morningstar Study Results

The result of the study showed an additional gain of 1.82% per year in terms of portfolio return, which allows 30% higher consumption during retirement, for those who adopt efficient financial planning.

It’s important to use the concept of gamma when presenting the value of financial planning to potential clients.

I think that it would be very beneficial to the profession if the concept of gamma became widely used, and as popular as its counterparts, alpha and beta. I would like to congratulate Morningstar and all project participants for the initiative.

Here is a link to the complete text, Alpha, Beta, and Now…Gamma, for those wanting more in-depth knowledge of the study.

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