By John K. McGill, JD, CPA, MBA, and Garrett Oakley, CPA
With the growing popularity of online discount brokerage firms and DIY investors, some doctors question the benefit of paying for financial advice. Unfortunately, the impact of good advice is difficult to measure in the short term, and most doctors mistakenly evaluate their advisors with a narrow focus on recent investment performance. As a result, these doctors fail to consider the positive impact that good financial planning advice and sound decision-making can have on long-term investment results.
To properly measure the impact of advisors, Morningstar Research directors David Blanchett and Paul Kaplan created a new performance metric to quantify the effect of good decision-making. Called "Gamma," this metric seeks to measure the value gained by investors through smart financial-planning decisions. Gamma can add up to an equivalent of 1.59% annual return to a doctor's portfolio by focusing on five key financial planning concepts. These are:
Total wealth asset allocation
Most doctors are familiar with the concept of asset allocation. In the process of building a portfolio, doctors select an allocation based on their perceived risk tolerance and the current market. However, this approach suffers from a critical flaw. Investors' perception of risk changes with the market conditions. Many of the investors who wish to get more aggressive today are the same people who panicked and asked to sell to cash in early 2009. An advisor can add Gamma by working with doctors to determine their true risk tolerance.
In addition to risk tolerance, Blanchett and Kaplan indicate that proper asset allocation decisions need to incorporate consideration for long-term retirement funding risks, primarily inflation. Good advisors can add Gamma by guiding doctors to structure their asset allocations in a manner to offset the income-eroding effects of inflation. Advisors can educate doctors on inflation's impact on future retirement spending to draw a realistic assessment of assets required for retirement.
Asset location/withdrawal sourcing
After determining the proper allocation, advisors can further Gamma's benefit by helping doctors structure their portfolios in the most tax-efficient manner for both current investments and future withdrawals. Generally, tax-deferred accounts such as retirement plan accounts and IRAs should focus on conservative and tax-inefficient investments, while after-tax accounts should be invested in aggressive and tax-efficient investments. During retirement, advisors can guide doctors to ensure distributions are made in the most-tax efficient manner. Taxes are extremely important, since most doctors lose up to 1% to 2% per year on tax inefficiency.
Dynamic withdrawal strategy
Earlier this year, we examined the "4% withdrawal rate" rule and determined that current market conditions and a low interest rate environment require doctors to withdraw less than 4% each year in retirement. The Blanchett and Kaplan report adds that the 4% rule is based on an initial income target and is rarely updated to factor in retirement investment performance or client longevity. A good advisor can add Gamma by using a more dynamic approach, where projections are frequently updated to determine whether retirement distributions remain at or below a safe withdrawal threshold.
Doctors fear running out of money more than they fear death. One way to hedge against this fear is to lock in an annuity stream. Rather than drawing from existing investments to purchase an insurance policy or annuity, a good advisor can help clients maximize a commonly overlooked annuity - Social Security. Advisors can add Gamma by analyzing estimated Social Security benefits to determine the optimal time to apply for benefits. Using a Social Security optimization strategy can add tens of thousands of dollars in annual retirement income.
Doctors have much to consider when evaluating whether or not to use the services of a financial advisor. Using the five concepts of Gamma, doctors can quantify the long-term benefits that good advisors can offer versus their fees.
John K. McGill, JD, CPA, MBA, provides tax and business planning through John K. McGill & Co., and Garrett Oakley, CPA, provides investment advice through McGill Advisors, Inc. (RIA). Both are members of the McGill & Hill Group, LLC, your one-stop resource for tax/business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit www.mcgillhillgroup.com.