Investment Glide Paths: How Much Risk Should You Take?

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Dr. Jim Dahle:
A glide path is simply the way in which your asset allocation, or mix of different investment types, changes over time. Classically, people take less risk with their investments as they get older, and so their asset allocation becomes more conservative, less aggressive, as they move toward retirement and then into and through retirement and approach their ending years.

Classically, people have started out with, you know, 80% or 90% or 100% stocks in their 20s, and then as they move toward retirement, they're down to, you know, 60% stocks or something like that, and they continue to reduce that risk they're taking throughout their lives. That is what most people mean when they say an investment glide path.

You can change that in intervals. You can change it every five years. You can change it every year and just gradually make it less aggressive as you go.

There is some pushback to this, of course. There are some studies suggesting that, yes, you do need to decrease the amount of risk you're taking right around the time you retire, but then can actually take more risk as you go throughout retirement. That might help protect your portfolio growth from high inflation, and so it deals with, you know, the sequence of returns risk where you're trying to avoid losing a bunch of money just before you retire or just after you retire.

Sequence of returns risk, of course, is that risk that you run out of money in retirement despite having adequate average investment returns to support your withdrawals because the poor returns came first, and withdrawing from a portfolio that's dropping in value is a pretty good way to decimate it quickly. That's sequence of returns risk, and so taking less risk in your portfolio around the time of retirement is a good way to reduce that risk.

So that's the main reason why investors change their asset allocation over time. They have been gradually converting their earned income, their potential income, into, you know, actual assets, physical assets that they're going to live on during retirement. So it's a gradual process as you put in your time and effort and sweat and tears throughout your career, as you're slowly losing time and you're gaining money, right? And because you have less to put in there as time goes on, you know, the idea is you take less risk as you go on.

There are funds called funds of funds or target retirement funds or lifecycle funds that try to do this for investors so they don't have to do this manually themselves. So if you go invest in a Vanguard Target Retirement 2060 Fund, they design it for somebody that's going to stop working in 2060.

So when you first start investing in that in 2020 or 2025 or 2030, it's going to be pretty aggressive, right? It's going to be like 90% stocks. Then as you get closer and closer to retirement, it'll be 80% stocks and 75% stocks and 70% and 65%, until the time you retire, maybe it's 60% stocks or 55% stocks. And then a few years after you retire, maybe it's even less than that.

That's the concept of a target retirement fund. Not only does it rebalance itself between the various different asset classes, but it becomes more conservative over time. So that can be a great one-stop solution, at least for those that invest only in retirement accounts like Roth IRAs and 401(k)s.

There's some reasons why maybe it's not a great asset to use in a taxable account, but it's a great one-stop shop, especially for a resident or somebody just starting to save for retirement with all their money in a Roth IRA or something like that.

So common mistakes people make when creating or following a glide path are maybe making it too steep, right, to where they get too conservative too early, or not making it steep enough, right? I mean, there are some people that haven't changed their mix of investments from the time they were 95% stock at 25, and here they are at 60, and they're still 95% stock. Well, maybe that's a little too much risk for you to be taking, and maybe you should have made that glide path a little bit steeper.

So those are the main issues: just not making it steep enough and making it too steep.

And what's right depends on you. You know, even the various financial companies that build these target retirement funds don't necessarily agree on exactly how steep that glide path ought to be. You know, they might differ by 10% in the stock-to-bond ratio. It might be different from one company to another, so it's best if you lift up the hood and look underneath and see how the glide path really changes as the years go by, and is that okay with me?

And you're not stuck with it as long as you didn't buy it in a taxable account. If you're like, I'd rather be a little more aggressive, you know, in five years you can change from the Target Retirement 2060 Fund to the 2070 Fund, and now your glide path won't become more conservative for a period of 10 years longer than it otherwise would have.

Really, when you're setting your asset allocation, you want to pay attention to your need, ability, and desire to take risk. So, hopefully, as time goes on, you acquire more assets, your need to take risk goes down. Now, maybe you're very wealthy, and your ability to take risk has actually gone up. Then you've got to figure out how those two things balance each other out.

But really, we're just talking about setting your asset allocation and how it's going to change over time. So I suggest when you put together a written investing plan that you actually decide in advance how your asset allocation is going to change over time.

You might decide, well, I'm going to do it all at once when I turn 55, planning to retire at 60. I'm going to go from 80/20 to 60/40 at age 55, five years in advance. That's the only change I'm going to make. I'm going to stick with that throughout retirement.

You can make it very simple, or you can do something like the target retirement funds are doing and become 1% less aggressive every year. It's up to you how you design your glide path, but give some thought to how your asset allocation is going to change as you move toward and throughout retirement.

The White Coat Investor Podcast is for your entertainment and information only and should not be considered financial, legal, tax, or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate professional for specific advice relating to your situation.