Glide Path: Definition, Types, & How It Works
A glide path is a financial term used to describe the trajectory of an investment. The term is most often used in relation to retirement planning, where it refers to the rate at which an investor’s nest egg is expected to grow and how it will be distributed among different asset categories as the individual approaches retirement. In essence, it is a way to map out how you expect investment to perform over time. The trajectory can be determined by taking into account a variety of factors, including the underlying security’s price volatility and expected rate of return.
How Does a Glide Path Work?
A target-date fund is a fund designed to provide an asset allocation that is appropriate for the near-term needs of investors who are retiring or retiring soon. The glide path of a target-date fund will change over time to become more conservative as it approaches its date of the target. A typical glide path starts with a higher percentage of the investment allocated to more aggressive or growth-oriented investments, such as stocks. This is designed to provide the investor with the potential for higher returns in order to help them build up their retirement savings over time. As the individual approaches retirement, the allocation to more volatile and risky investments will be lowered and replaced with more conservative options, such as bonds and cash. This will help to ensure that the investor’s nest egg does not experience a large decline in value as they near retirement age.
Types of Glide Paths
There are three different types of glide paths used in finding the right asset allocation for an investor:
Static Glide Path
With this glide path, you use the same target asset allocation from the time you start investing until the day you retire. It is set in stone and remains the same regardless of market conditions. For example, a 30-year old might have a portfolio that is 60 percent stocks and 40 percent bonds. This stays unchanged until the individual reaches retirement age – even if those stock values go up or down along the way. This type of glide path is usually used by investors who are very risk-averse and want to avoid any potential losses as their retirement approaches.
Declining Glide Path
This type of glide path starts with a more aggressive asset allocation, which then becomes more conservative as the target date nears. A classic glide path formula is: For example, a 25-year old might have a portfolio that is about 80 percent stocks and 20 percent bonds. This will become more conservative as the target date gets closer, for example: 100 – 30 = 70 percent stocks/30 percent bonds The declining glide path can be seen as a more balanced approach between risk and safety than the static glide path.
Rising Glide Path
Portfolios that use this approach have a larger amount of more risky assets, such as stocks, at the younger end of the time frame. As the bond matures, they will then shift towards more conservative investments that carry less risk to them. For instance, a 40-year old might have a target asset allocation of 75% stocks and 25% bonds. As they approach their retirement date, the stock portion will decrease as more cash is added to the portfolio. This type is usually seen as ideal for individuals who do not want to take on too much risk early on but also want the potential for higher returns as they get closer to retirement.
Which Method Is Right for You?
The glide path you choose will depend on a variety of factors, including your age, risk tolerance, and investment goals. If you’re young and have a high-risk tolerance, you may want to stick with a more aggressive allocation that favors stocks. However, as you get closer to retirement, you’ll likely want to shift more of your assets into safer investments like bonds. For example, here is a common glide path for someone in their 30s:
- 30% stocks
- 40 % bonds
- 30% cash equivalents
This would mean that, as the individual gets closer to retirement, the allocation would increasingly favor safer assets like bonds and cash equivalents. On the other hand, if you’re older and don’t want to take on as much risk, you may want to opt for a more conservative glide path that favors less volatile assets. For example, here is a common glide path for someone retiring in their 60s:
- 20% stocks
- 40 % bonds
- 40% cash equivalents
As you can see, this glide path would gradually shift away from stocks and into safer investments like bonds over time. Another important factor to keep in mind is your investment goals. If you’re looking to preserve your capital, you may want to consider a more conservative glide path. However, if you’re looking to generate income in retirement, you may want to consider a more aggressive allocation that includes stocks. The important thing is to choose a glide path that aligns with your specific needs and goals.
Benefits of Glide Path
There are a number of benefits to using a glide path, including: Increased Predictability: A glide path can help investors achieve more predictable returns and avoid any potential surprises. Reduced Risk: Allocating assets in a more deliberate manner can help reduce overall portfolio risk. Easier Retirement Planning: Having a glide path in place can help make retirement planning easier and more straightforward. Increased Diversification: By adding volatile assets like stocks into a portfolio, you will be able to build a more balanced mix of investments that carry less volatility and risk. Making an investment plan with a glide path is one of the most effective ways for investors to ensure their money is working hard for them and their retirement goals. When done correctly, a glide path can provide the right mix of risk and safety, making it easier to reach your long-term financial goals.
Limitations of Glide Path
There are a few potential limitations to using a glide path, including: Potential for Poor Performance: If the stock market performs poorly, investors who have a more aggressive glide path could see their portfolio value decline. Possible Higher Fees: Some investment firms may charge higher fees for those who want to use a glide path. Limited Investment Options: Not all investment firms offer glide path options, which means they may not be the ideal choice for some investors.
A glide path is an effective way to take your investment plan and level out the volatility of equity exposure. It’s important for each investor to pay attention to their own circumstances, risk tolerance, and retirement goals when determining which glide path would be ideal. While using a glide path can help reduce risk in certain instances, it may not be right for everyone. The key is finding the glide path that’s appropriate for your situation and meets your specific needs. By doing so, you’ll be able to help maximize the potential of your portfolio, while taking steps to mitigate risk along the way.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.