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
Target retirement funds almost universally begin with high equity allocations for young investors. However each fund group establishes a glide path for its series of target funds, and these glide paths vary considerably. In general, however, a fund's glide path will follow one of three methods: straight line, stepped, or rolldown.


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


 * 2. Stepped: With a stepped glide path 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.


 * 3. Rolldown: This glide path method 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.

Target retirement fund managers justify high equity allocations for young investors on the grounds that a long time horizon allows the investor plenty of time to recover from the down cycles of markets and that the large amount of human capital (future lifetime earnings)  the young investor possesses provides the investor ample opportunities for increasing the personal savings rate when the markets decline. In the meantime the investor can garner a greater percentage of the expected equity return premium over an investment career by holding the higher equity allocation. While a target date's glide path will slowly reduce the equity allocation over the lifetime of the investor, target date funds ordinarily hold a considerable allocation to equity investments as an investor approaches retirement age. These allocations are attributable to the fact that most target retirement funds are designed to be held through the planned retirement date and held over the entire period of the investor's retirement phase. Firms with high post retirement equity allocations base their asset allocation decision on the expected increased longevity of post retirement accounts. The lengthened time horizon allows time for recovery from market down cycles during the early stage of retirement, and, assuming a realization of an expected equity return premium, the portfolio will have a higher value to help mitigate the risk of having reduced income at the end of a long life.

The dispersion of equity allocations in the universe of target retirement funds is a narrow 2.5% in the 2055 series of target date funds. This dispersion of equity allocations widens to 40%-50% as the target series approaches the retirement years. For example, the range of equity allocation in 2010 target date funds falls between a low 26% allocation in the Wells Fargo Advantage 2010 fund and a high 72% allocation in the Alliance Bernstein 2010 fund. Figure 4. illustrates the diversity of glide path allocations.

The divergence in asset allocation resulted in a wide dispersion of returns in the 2008 market collapse. Losses in the 2010 target fund series ranged from -9% to -41%. . Clearly, two funds bearing the same target date can have markedly different portfolio allocations, risk exposures, and returns. These performance disparities have drawn the attention of the SEC and the Congress.

Target Retirement Fund Indexes
Index providers Dow Jones, Standard and Poors, and Morningstar have developed indexes for benchmarking target retirement fund portfolios. Dow Jones and Morningstar employ risk based metrics in devising the index glide path. S&P attempts to mirror the glide paths used by the actual target funds comprising the market.The Index glide path methodologies are outlined below:


 * 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 Target Date 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.

The following table provides the Index equity targets for selective ages: a youthful starting date; a date ten years prior to a common retirement date; a common retirement age; and a date five years after retirement. The glide paths of the seven largest mutual fund managers is also provided in the table. The benchmark indexes can help investors gauge the relative riskiness of a given target retirement fund's guide path strategy.

College Savings Plans Glide Paths
The time horizon for a child's college savings is bounded by the assumed ages of college enrollment (18-22). The glide paths of 529 Savings Plan age-adjusted portfolios are therefore usually much more conservative than those used in the retirement plan market. Many plans transition portfolios to hold 100% cash or 100% cash/fixed income portfolios at age 18+. However, as in the retirement plan market, there is a wide variance in the range of stock allocations for the 18-22 age period. Many 529 savings plans offer risk-based portfolios (Conservative, Moderate, and Aggressive) and the equity allocations for the 18+ age group in many aggressive portfolios range from 10% equity to 65% equity.

The following table shows the glide path allocations for the three largest 529 Plan vendors in the direct market 529 plan universe, Vanguard, TIAA-CREF, and Fidelity. The allocations are provided for equity investments, fixed income investments, and money market fund investments.

A large plurality of Vanguard 529 plans follow the glide path illustrated in the table. However some states (Illinois and Indiana) hold a 10% equity allocation in the 18+ age band. Iowa, Missouri, Nebraska, and North Carolina supply a 20% equity allocation in the aggressive allocation portfolios. Utah's option 3, the most aggressive allocation in that state's plan, holds a 65% equity allocation at age 18.

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.

Index Methodology Statements

 * Dow Jones Target Date Methodology
 * Morningstar Target Maturity Methodology
 * Standard & Poors Target Date Methodology
 * A Better Mousetrap, Craig L. Israelsen, Financial Advisor Magazine (February 2008)

Forum Conversations

 * Target Retirement Funds Allocation
 * "Fixing" Target Retirement Funds
 * Bogle on Target Date Funds
 * Google Forum Search:Target date fund glide paths

Research Reports

 * Target-Date Series Research Paper: 2009 Industry Survey
 * Target Date Indexes–Comparison Grid
 * Savingforcollege.com’s age-based allocation study (Nov 2008)

Industry Sites and Reports

 * How Fidelity Freedom Funds Work
 * PIMCO: Creating the Next-Generation Glidepaths for Defined Contribution Plans
 * Revisiting T. Rowe Price’s Asset Allocation Glide-Path Strategy
 * Vanguard Target Retirement Fund Glide Paths