An equity glide path refers to key shifts in the asset allocation of stocks, or equities, in your account over time. You use your age at any given time to decide how to spread and manage the assets you will need to tap into when you retire. For example, a target-date retirement fund changes its asset allocation based on how close you are to the date you plan to retire. Over time, though, it likely will become more conservative and hold more bonds. Most funds will be more aggressive initially, holding more stocks. The type of glide path you choose will decide the percentage of equities in your account. It will also determine whether the number of equities that you hold will increase, decrease, or remain the same as you get older and approach retirement.
How an Equity Glide Path Works
If you’re saving for retirement, you will probably be advised to have a diverse portfolio that includes stocks, bonds, and cash, to avoid giving too much weight to any given asset class. Having diverse assets lowers the risk of losing money in the market. Not all asset classes carry the same level of risk. Stocks often carry more risk than bonds. They can fluctuate a lot in price, which means that you can lose money in the short term. These fluctuations also mean they experience more growth, which gives you higher returns in the long term. In contrast, bonds experience both less growth and lower fluctuation. That means they are less risky in the short term but bring lower returns in the long term. Savers should shift their assets over time in a way that evens out risk and returns and gets them to their investment goals. Such shifts are known as “equity glide paths.” Suppose you’re 25 years old and want to retire at 65. Because the time until you retire is 40 years, your investments can weather the downturns and decline in value from an allocation that comes with more risk. As you steer away from more risk as you age, you opt for an asset spread that follows a declining glide path. With this type of glide path, the amount of equities you have in your account goes down as you age. You could buy individual funds and change your portion over time to decrease the tilt toward equities in your account. You also could buy a target-date retirement fund, which often will be named after the calendar year in which you expect to retire. These funds are usually managed in such a way that the risk level goes down as you near the target date without you having to change things on your own. A target-date fund that is 40 years away from its date might start with an equity spread of 95%. Twenty years later, it might drop to 70% equities. By the time it reaches its target date, the percentage of equities held could be 50% or less. This glide path is followed by trading stock for less risky investments over time.
Types of Equity Glide Paths
There are main three main types of glide paths.
Declining Retirement Equity Glide Path
A declining equity glide path is where you slowly reduce your exposure to equities as you get older. If you were to plot this path on a line graph, with age as the X axis and the amount of equities you hold as the Y axis, the line would have a negative slope. The “100 minus your age” rule of thumb is one way to look at a declining glide path. This rule of thumb says that to figure out how much you should have in equities—stocks or stock index funds—you should subtract your current age from 100. For instance, at age 60, you would have 40% of your funds in stock equities, with the rest in safer asset classes like bonds. Each year, you would reduce your equities portion by 1% and increase your bonds by that amount.
Static Equity Glide Path
A static 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 change the balance of your portfolio to return to that target spread. If you were taking money out of your account—using a systematic withdrawal approach—you would take enough from each asset class that the spread would remain at 60% equities and 40% fixed income after your withdrawal. Suppose, for example, that at the start of the year, you have $100,000. You have 60% of that amount, $60,000, in a stock index fund, and 40% in a bond index fund. But by the end of the year, the stock index fund is worth $65,000, and the bond index fund is worth $41,000. You also need to take $4,000 out of the account. After you take out that amount, you will have a balance of $102,000 left. To maintain a 60/40 spread, you will want to have $61,200 in equities and $40,800 in bonds. You would divide your $4,000 between the two asset classes to achieve that, selling $3,800 of your stock index fund and $200 of your bond fund for a total of $4,000.
Rising Equity Glide Path
A rising equity glide path is the reverse of the declining glide path. As you age, your equities portion would slowly increase as long as they earned a positive rate of return. Such a path would produce a line with a positive slope when plotted on a line graph. This might be an approach where you start with a larger portion in a low-risk asset class like bonds—perhaps 70%, and 30% in equities. You might create a bond ladder where bonds mature each year to meet the amount of money you will need to take out of the account. The equity portion of your account might grow to around 70% over time.
Which Glide Path Is Best?
The declining glide path that calls for decreasing portfolio exposure to equities over time is aligned with many people’s low tolerance for risk as they age. Still, some experts have hailed the static glide path as the best approach. Financial expert Bill Bengen, for example, has stated that a static equity spread of 50% to 75% is ideal. Retirement experts Michael Kitces and Wade Pfau found that a rising glide path, such as one starting with 30% in equities and going up to 70% over 30 years, yields better outcomes than a static or declining glide path. Aside from research, there is no way to know in advance which type of glide path will bring you the best outcome for the market ups and downs you will meet when you retire. Your best option is to assess the time you have until then, your tolerance for risk, and your investment goals. Then, pick the approach that suits you best, and maintain it in a careful way.
