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By Christine Benz and David Blanchett | 10-15-2012 04:00 PM

Create More Income With 'Gamma'

David Blanchett explains how a new Morningstar metric captures the extra income an investor can earn by making better financial decisions.

Christine Benz: Hi, I'm Christine Benz for Morningstar.

Many investors are familiar with alpha and beta, but Morningstar researchers have created a new measure called gamma. Joining me to discuss it is David Blanchett; he is head of retirement research for Morningstar.

David, thank you so much for being here.

David Blanchett: Thank you for having me.

Benz: David, you've written a paper about gamma. Let's talk about what the measure is.

Blanchett: Well, first, you mentioned alpha and beta. Alpha is if you pick a good mutual fund that beats its peers by 1%, that's alpha. Beta is, I'm going to put 60% of my money in stocks, 40% in bonds. Beta is how much you invest in the market. And then gamma is the benefit of making good financial-planning decisions. So, it's all that alpha and beta is not. It's the value you achieve from making intelligent choices about how to manage your money.

Benz: So, you looked at the value that one might add by successfully managing gamma. How impactful can that be in terms of a portfolio's overall results?

Blanchett: We find it was significant. In this research paper, we look at five different things, and there is probably more like 19 different things. We found that you can create 29% more income for a retiree by just doing these gamma-optimized things.

Benz: Okay. So, that's a big number.

Blanchett: Yes.

Benz: Let's start with one of the first components that you looked at--you called it total wealth allocation. I want to talk about how that's different from the traditional understanding of asset allocation?

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