What is an Equity Glide Path?
An Overview of Equity Glide Paths and Asset Allocation
Everyone wants to find the very best way to invest their money in retirement. In order to test different investment approaches, researchers often start with what is called an “equity glide path”.
An equity glide path is the projected change, or path, in the asset allocation of your investments as you age. Below are examples of three different equity glide paths.
1. Declining Equity Glide Path
A declining equity glide path is where you gradually reduce your allocation to equities as you get older.
The “100 minus your age” rule of thumb is an example of a declining equity glide path. This rule of thumb says that to determine how much you should have allocated to equities (stocks, or stock index funds for example) you should take one hundred minus your current age. At age 60 you would have 40% of your invested funds in equities. Each year you would reduce your allocation to equities by 1% and correspondingly increase your allocation to bonds. This is called a declining equity glide path, as the amount you have allocated to equities would goes down as you age.
2. Static Equity Glide Path
A static equity glide path would be an approach where you maintain a specific strategic asset allocation, such as 60% to equities and 40% to bonds. Each year you would rebalance back to that target allocation, or if you were taking withdrawals using a systematic withdrawal approach you would take enough from each respective asset class that after your withdrawal the allocation remained at 60% equities and 40% fixed income.
Using a simple example assume at the beginning of the year you have $100,000 and 60% of it, or $60,000, is in a stock index fund and 40% is in a bond index fund. By the end of the year assume the stocks index fund is now worth $65,000 and the bond index fund is worth $41,000. Now assume you need to take a $4,000 withdrawal.
After your withdrawal you will have $102,000 left. To maintain a 60/40 allocation you will want to have $61,200 remaining in equities and $40,800 in bonds. Thus you would sell $3,800 of your stock index fund and $200 of your bond fund. (Ok, in reality you would likely not place a trade to sell $200 of your bond fund – you might just take the full $4,000 out of the stock index fund as $200 becomes an insignificant amount relevant to the size of the portfolio and if there are trading costs it likely would not make sense to pay them for a $200 trade, but I’m using it here for the sake of illustrating how to maintain a static equity glide path.)
3. Rising Equity Glide Path
A rising equity glide path would be an approach where you might start with a larger portion in bonds (such as by creating a bond ladder where bonds mature each year to meet your needed withdrawal amounts), perhaps 70% of your portfolio, and slowly spend it down, allowing the equity portion of your account to grow over time. Thus, as you aged your allocation to equities would gradually increase, assuming they earned a positive rate of return.
How Equity Glide Paths Are Used in Mutual Funds
The term equity glide path began to be used more frequently with the increase in the number of target date retirement funds.
A target date fund typically has a calendar year in the name of the fund, such as Target Date 2030, and the funds are usually managed so the risk level decreases as you near the target date. This is typically accomplished by decreasing the allocation to equities as you get closer to the target date of the fund. Even though two target date funds may have the same date, such as 2030, they can be invested quite differently depending on their equity glide path. One fund may reach its target date with an allocation that is nearly all bonds, while another may reach its target date with an allocation of 50% to bonds.
Which is Best?
There is no way to know, in advance, which type of equity glide path will deliver the best outcome over the economic and market conditions you will encounter in your retirement years.
Your best option is to pick the allocation approach you want to use and maintain it in a disciplined way. The worst thing you can do is constantly switch between approaches.