What Is A “Glide Path” Formula, And What Should You Know?
It’s more or less a given that the asset allocation of a person’s retirement portfolio should evolve as they age. Many advisors use the glide path formula to achieve the appropriate balance.” Eric Coons
Thousands of advisors use an investment strategy known as the “glide path” to adjust the mix of investments in their clients’ portfolios. It’s a popular way to minimize risk as a person ages and helps clients stay focused so they can achieve a successful retirement and other long-term financial goals. A glide path approach also underpins certain kinds of investments, such as target-date funds.
While there is no standardized “recipe” for creating glide path formulas, a pre-retirees age or target dates usually determine how much of their money should be in stocks, safe money instruments, and cash. Risk tolerance, which has a tendency to decrease with age, is also taken into account. As you can probably guess, advisors using glide path formulas tend to reduce exposure to equities the closer you are to a certain age or target date. This shift in asset allocation is the glide path. Discovering more about glide path formulas can help you formulate your retirement blueprint.
There are three main kinds of glide paths used by advisors to determine the correct asset allocation for a retirement portfolio: Static Glide Path, Declining Glide Path, and Rising Glide Path.
Static glide path: This method uses the same target asset allocation but rebalances the portfolio occasionally to keep on track.
Declining glide path: Common to many target-date retirement funds, a declining glide path strategy uses a target year or a target decade as the basis for asset allocation choices. You may have heard, for example, that “100 minus your age” gives you a good idea of how much stock to include in your retirement matrix. It’s an interesting rule of thumb that, given today’s volatile economic environment, that may no longer work for most people.
Rising glide path: The rising glide path is the least popular formula. Typically, a rising glide path begins with an allocation more heavily weighted in bonds and safe money instruments, and it then shifts to include more equities as the bonds mature. As the bonds mature, the idea is to purchase equities in the portfolio. Some advisors use this method to protect against a “sequence of returns” risk when a portfolio experiences significant losses during the first few years of retirement.
Why would a retiree use a glide path strategy?
As you get older, you could find that your risk appetite has lessened considerably. Designing an account that better reflects your desire not to lose money when you retire requires constant assessments, rebalances, and occasionally a total rebuild. This continuous tweaking can be expensive, time-consuming, and frustrating even for those who enjoy working with money. The solution to making a lot of manual adjustments as you age is to use a glide path strategy that automatically adjusts to suit your risk tolerance. For instance, you may discover that you want to shift more of your money to bonds, annuities, or life insurance to help you preserve your cash for when you need it the most.
Using a glide path can help you manage the shift from riskier Wall Street investments to lower risk, income-producing assets as you near or enter retirement. However, designing a glide path is not an exact science, relying on rules of thumb and educated guesses rather than pure math because none of us knows exactly how many years we’ll spend in retirement. There are other factors, such as debt reduction, that have a tangible effect on your portfolio.
Bottom line: Glide path formulas are one of many ways to ensure your portfolio is more balanced and better reflects your risk tolerance as you age. Before settling on any one method, meet with your advisor, and they will help you discover and evaluate your options for creating a more efficient and profitable retirement strategy.