Glide paths

In the investment world, the term glide path refers to the process by which a target date fund changes its asset allocation among risky assets (which can include stocks,  international stocks, REITS and  commodities) and lower risk assets such as   bonds,  inflation indexed bonds and  money market funds over a time horizon. Target date funds include target retirement funds in the retirement plan market, as well as  age-adjusted portfolios in the college savings plan market. The glide path of a target fund shifts from high risky equity allocations at inception to ever higher fixed income investments as the target date approaches.

Target Retirement Funds Glide Paths



 * Straight Line: A straight line glide path (see  Figure 1 ) takes a steady, linear approach that gradually reduces the equity weighting of the portfolio over time. Vanguard and TIAA-CREF take this approach.


 * Stepped: With a stepped glide path (see  Figure 2) the equity allocation is held steady until periodically adjusted. ING takes this approach. In their stepped glide path, during the first three decades the adjustment is made every ten years; subsequent adjustments are made in five year intervals.


 * Rolldown: This glide path method (see Figure 3) holds high levels of equity allocations until approximately twenty years before the retirement date, when a sharp reduction in the equity allocation begins, extending through the decumulation stage. Fidelity takes this approach.

Index Glide Path Methodologies:
 * Dow Jones Target Date Indexes : Glide path follows a monthly equity risk exposure reduction formula, from 90% to 20% of the total equity risk.
 * S&P Target Date Indexes: Glide path is a scrubbed average of nearly all active TD fund equity allocations – consensus glide path is the objective.
 * Morningstar Target Date Indexes:Modern Portfolio Theory-based asset allocation, optimized to human capital asset assumptions. Liability-driven investment (LDI) approach using investor balance sheet construct for surplus optimization. Indexes are provided for three risk profiles: conservative, moderate, and aggressive.

[source: Morningstar]

Individual Retirement Portfolios and Glide Paths


As mentioned in the Bond Percentage Equal to Your Age, many people prefer not to keep a static stock/bond allocation throughout their retirement, but to gradually have their portfolio become more conservative by reducing the stock allocation and increasing the bond allocation as they age. However, the rule-of-thumb method where your bond percentage is equal to your age is sometimes seen as a bit too conservative. Another method, similar to the allocations used by some retirement-date funds is to follow a glide-path allocation change that isn't necessarily directly linear, as is the bonds=age method. Often, a glide-path method will add bonds to the portfolio mix more slowly in the early years before retirement, thus allowing the portfolio more possibility for growth before retirement. Then, after retirement, the glide-path may transition more quickly to a bond-heavy allocation, thus shielding the portfolio from stock market volatility during later retirement years. Figure 4 shows a graph comparing the (100-age) stock allocation and the Log(100-age)-1 glide-path allocation. The blue (100-age) line is linear, changing the allocation by 1% each year. The glide-path allocation changes more slowly in the earlier years, presumably allowing for more portfolio growth during the accumulation years, and then turns quicker towards a more conservative allocation during the retirement years, eventually becoming more conservative and following a 100% bond allocation for age 90 and later.

As with the similar Bond Percentage Equal to Your Age method, following a glide-path stock/bond allocation allows the overall portfolio to become more conservative each year. The results, shown in Figure 6, are similar to the Bonds Equal Age method, but in the time-period shown in the graph, the slower transition to bonds allowed the overall portfolio to grow a bit more, resulting in slightly more money being withdrawn from the portfolio, while retaining a similar volatility.

Links

 * Investopedia
 * Vanguard Target Retirement Fund Glide Paths
 * How Fidelity Freedom Funds Work
 * Revisiting T. Rowe Price’s Asset Allocation Glide-Path Strategy
 * Target Date Indexes–Comparison Grid
 * Target-Date Series Research Paper: 2009 Industry Survey
 * Savingforcollege.com’s age-based allocation study (Nov 2008)