In investing, a “glide path” describes how and when a portfolio gradually becomes less risky as you move toward retirement. The concept is perhaps best known with regards to Target Retirement and Lifecycle funds where you pick the “Fund of Funds” by the date of retirement. The mutual fund company has its experts decide on what the ideal glide path should be and then implements it as your retirement date approaches.
A Traditional Glide Path
Graphing the asset allocation of the Vanguard Target Retirement Funds gives you an idea of what a “typical” glide path might look like, but there are significant differences between the various mutual fund companies, as discussed here.
Vanguard Target Retirement Fund Glide Path
As you can see, an investor who is 25+ years away from retirement gets put into a portfolio that is 90% stocks and 10% bonds. That gradually decreases until at retirement it is about 55% stocks and 45% bonds. Then, about 8 years after retirement, it shifts to a portfolio of about 30% stocks.
There are a few things worth pointing out there.
- This is the Vanguard experts' idea of what a proper glide path should look like.
- They never have more than 90% stocks, or less than 30% stocks. This is somewhat similar to Benjamin Graham's rule to keep your stock allocation between 75% and 25%.
- The glide path becomes less aggressive as you go on. The glide paths of other Life Cycle funds are similar, sometimes a little more aggressive, and sometimes a little less aggressive, but basically they look the same. The main idea is that as you turn your “human capital” into “real capital” as you move through life, the less ability you have to take investment risk since you have less time to make up for losses.
A Glide Path Is Not Investing Doctrine
However, the concept of a glide path is hardly investment gospel. There isn't much data that suggests you should be following a glide path at all. The whole concept really comes from rules of thumb, like “hold your age in bonds” popularized by people like Jack Bogle. In this post, I'd like to point out a lot of other ways to do it, and explain their merits over a more traditional glide path.
7 Considerations for Designing Your Personal Glide Path
#1 Decrease Your Stocks By Age
One popular way to design your own personal glide path is by your age. I've seen “Bond percentage = Age,” I've seen “Bond percentage = Age- 10,” and I've even seen “Bond percentage = Age – 20.” So a 20-year-old would have a portfolio between 100/0 and 80/20, a 40-year-old would have a portfolio between 80/20 and 60/40, a 60-year-old would be between 60/40 and 40/60, and an 80-year-old would be between 40/60 and 20/80. The whole idea behind it is that someone who is older doesn't have as much time to recover from a temporary loss in the stock market, so he should have less of his assets in the stock market.
#2 Decrease Your Stocks by Time to Retirement
One problem with determining your asset allocation by age is that people retire at wildly different times. From the early retirement extreme folks retiring in their 30s, to the very early retirees in their 40s, to the early retirees in their 50s, there is a 30-year difference, even between those who “retire early.”
So perhaps the asset allocation should be determined not by your age, but by how far you are from retirement. So someone who is ten years out from retirement will have the same portfolio, whether they are 40 or 60. This is essentially how most Target Retirement/LifeCycle funds work.
#3 Decrease Stocks By Percent of “Enough”
However, why should time be an important factor at all? I mean, the real way to determine an asset allocation depends on your need, ability, and willingness to take risk. Someone who has almost enough to be financially independent has a whole lot less need to take risk than someone who only has 1/4 of their “number.” For example, perhaps the glide path looks like this:
- 0-10% = 100% stock
- 11-30% = 80% stock
- 31-60% = 70% stock
- 61-90% = 60% stock
- 91-110% = 50% stock
- 111%-150% = 40% stock
- 151%+ = 20% stock
#4 Why Decrease Stocks At All?
Perhaps the whole dogma that you should take less risk as you go along is wrong. Perhaps it is reasonable to hold the same asset allocation your entire life. You determined early on what you could tolerate as far as volatility and you just stuck with it.
Lots of people argue that your portfolio should just be 100% stock anyway except for money you need in the near future. I never hear real estate investors talking about needing to maintain a balance between equity real estate investments and hard money lending. Maybe the whole concept is wrong.
#5 Why Not Get MORE Aggressive?
In fact, there is a halfway decent argument that you can get more aggressive as you go along. You have gotten used to the volatility of your portfolio, and so each succeeding bear market bothers you less and less. In addition, you have more and more resources as you go along, so even if you lose a big chunk of them, you still have more than you used to.
Wade Pfau has argued that while you should have a relatively conservative portfolio around the time of retirement (a few years before and after) to reduce sequence of returns risk, you actually have a better chance of not running out of money in retirement by INCREASING your stock percentage throughout retirement.
Perhaps the best glide path is some combination–low risk early on when you don't have much, increasing risk throughout your 30s and 40s as you need your money to grow, then decreasing towards 60 to reduce sequence of returns risk, and then increasing again in retirement.
#6 Why A Smooth Transition?
In fact, as long as we're questioning investing doctrine, why have a smooth glide path? Why not just make big wholesale changes from time to time? Perhaps you can stay 75/25 from age 25 to age 55, then go to 50/50 all at once. And why make your changes dependent on age, time to retirement, or even a ratio of your assets to your “number”? Maybe the changes should be dependent on market valuations. Doesn't it seem smarter to reduce your risk five or six years into a bull market than one year into a bear? Obviously, this isn't much different from timing the market with all the risk that entails.
#7 The Effect of Debt Reduction
While we're on the subject of glide paths and asset allocation, let's take a moment to discuss how debt reduction affects your true asset allocation. In reality, your debts like mortgages and student loans are negative bonds.
So if you are a young attending with a $100K portfolio that is 50% stocks and 50% bonds, but still owe $100K in student loans and $400K on a mortgage, in reality, you don't have a 50/50 portfolio. Your $50K in bonds is more than completely canceled out by the $500K in debt. Even with a million dollar 50/50 portfolio and a $200K mortgage, your real asset allocation is more aggressive than you might think. You have $500K in stocks, $500K in bonds, and $200K in debt. So in reality, your portfolio isn't 50/50, it's 63/37.
So as you pay down debt throughout your life, your portfolio NATURALLY becomes less aggressive, even if you maintain the same asset allocation over time. Do you really need to decrease it further?
What Should You Do?
There are obviously many ways to skin a cat, and I have no idea what the right glide path is for you or anyone else. I can tell you what we've done since we started investing halfway through residency–nothing. We set a 75/25 portfolio then and we basically still have it. Whether that is right or wrong, I have no idea. And that's the point. Nobody knows. There is no right way to do this. Like with asset allocation, pick something reasonable and stick with it. In fact, this is a great thing to incorporate into your written Investing Policy Statement, but I confess we do not even address it in ours.
I'm pretty partial to the idea of reducing risk depending on ratios of how much you have to how much you need. Like rebalancing, that forces you to sell high and buy low and to naturally take less risk as your need to take risk falls. I'm also a bit partial to making bigger changes to your ratio from time to time, rather than a tiny change every year. I also like the idea of making changes that reduce your stock to bond ratio at some point in the investing cycle other than right after you experience big losses in stocks.
Remember that there is little benefit to a perfectly finely tuned asset allocation. It just doesn't matter THAT much, especially when compared to other things like your income, savings rate, and ability to stay the course. I mean, a 65/35 portfolio performs nearly the same as a 60/40 portfolio. So I expect at some point as we approach “enough” that we'll cut back to 60/40 or something like that.
What do you think? Do you have a glide path? How is it determined? Which of these “glide path” ideas are you partial to? Why do you think the classic glide path has become such a prominent investment dogma? Comment below!
Great article. Thanks for the discussion. When writing my IPS, I struggled with my glide path too. I decided to start at 80/20 and increase bonds 2% per year until I reach 60/40. I chose a gradual glide path so that I could rebalance with new contributions in my taxable account (I also rebalance in tax-advantage accounts). I would like to retire when I hit 60/40 (currently at 72/28), so I believe it is important to have bonds in both taxable and tax-advantaged accounts. So far, this has worked really well and I have not had to sell in my taxable accounts to rebalance. I purposefully avoided an IPS that required large changes in asset allocation so that I would not have to sell equities or bonds when it was time to rebalance. I suppose the downside to this approach is that one might get slightly lower returns since the equity allocation would be temporarily less than it would have been otherwise.
Bill I don’t fully understand. Why do you have to sell equities to rebalance? You are still putting money into the funds, right? I would just add more or less to each part of our portfolio to balance- really good stock market years it could be all bonds, bad all stocks.
Lets say one has a 3MM portfolio at 70/30. When changing the allocation to 60/40, that would mean one goes from 2.1MM equities and 0.9MM bonds to 1.8MM equities and 1.2MM bonds. That would hard for me to swing in one year without selling anything. That’s why I do the gradual glide path, so new contributions can take care of it. Now, it is true some of this is in tax advantaged accounts, so selling could occur there, but in my case, it still wouldn’t work perfectly for me. This isn’t perfect, it just works for my situation (I think). YMMV.
OK we’re saying the same thing- just use new contributions to rebalance. In the withdrawal phase I’m choosing my (taxable since under 59 still) funds to sell for rebalancing purposes. And each sale decreases the amount of Roth conversion I can do this year at this tax bracket.
Yea, I’m not sure I follow that reasoning either. I mean, it’s fine to gradually reduce your ratio, but I’m not sure it somehow makes rebalancing easier. Also, make sure you know about the SEPP provisions to get to retirement money before age 59 1/2.
My recommendation is a constant asset allocation before, during, and after retirement which is:
Emergency fund and spending needed for the next ~3 years in short-term reserves + An asset allocation which is a notch more conservative than what your stomach could handle in a major downturn. I could probably handle near 100% stock, but I’m at about 92% stock now, if you count REITs as stocks. I’m early-retired.
I appreciate articles like this one, that support thinking about the options.
Personally, I am 100% in stocks (sort of, really more like 50% stocks and 50% rental properties), at the age of 56.
I always intended to do a glide path when I got within 10 years of retirement. I have never seen a good reason to not be fully invested in the best asset classes, until retirement was looming.
But, by being fully invested, I now have just under 50X annual spending saved. So, now I see no compelling reason to get into bonds, ever.
At this point I am investing for my legacy, which will be my kids and philanthropy in my community. A major market crash might impact the legacy, but shouldn’t affect my lifestyle.
When you state that you are 100% in stocks at 56 years old, most people slightly lose their minds (or think I have lost mine), but articles like this should get more people to think about their own situations and avoid the dogma that passes for wisdom.
When we moved to the FL panhandle area in ’06 one of my new friends was a real estate mogul on the FL coast planning her charitable legacy. You now the rest of the story- of course as a doctor’s wife they’ll be okay but had they stayed in all stocks she’d be closer to her charitable foundation than she is now. I lose my mind at the idea of managing 50% of my fortune in rental properties (95+% stock would be fine with the rest in cash equivalents at my lower multiple of annual spending saved) but I can’t even maintain and get appreciation in the home we live in so I presume you are a lot smarter and better at it than I could ever be. I just hope the business will maintain value (or enough value) even if there’s a housing collapse where you are (if concentrated in one area) or your health or sharpness diminish and even that your heirs will be able to benefit after your death (either able and willing to run your empire or to sell it for a fair price). Now if I had 1/4 your savvy I’d probably own REITs etc. (now under 1% of our portfolio, and that much shrinking).
Could be worse. If 50% of your net worth in rental properties seems insane, imagine if 2/3 of it were in some dumb website.
Stock risk and real estate risk all seems kind of silly to a lot of entrepreneurs.
🙂 🙂 !!
Excellent point. By staying aggressive now you can stay aggressive! That said, you certainly don’t have a NEED to take risk, so consider that as well. I mean, there are times when both stocks and rents tank, although rents tend to be a bit sticky (it just shows up as vacancies.)
Agree, at some point you dont need to be taking on 100% risk. Theres no need to just pick 60/40 which is largely an anchor bias picked from a historical bond bull run because it happened to perform so well. Its essentially a kind survivorship bias that will not repeat. Bonds still function as an insurance of sorts, they just payout less than they used to.
I would probably convert a portion of your equity portfolio over to muni bonds with the idea of covering some percentage of spending, maybe 15-25% more than annual. I would try to cover that with 60% of current portfolio dividends and the rest muni/bond coupons. I dont think that would give you a crazy bond allocation but would definitely give some peace of mind with a large margin of safety built in.
You could even dilute that further by taking say 50% of whatever rent profits you get into account as well, no reason to forget about those.
Agreed that I don’t need to take on 100% risk, but my point is that you reach a point where the risk becomes almost nonexistent.
My opinion is that once you are at 50X your retirement spending amount in invested assets, you can plan as if you are immune to risk, for the most part. That allows you to invest for your heirs or your legacy.
Just because it is possible to get completely defensive once you have saved enough, I don’t think that makes it the right thing to do.
Hello,
The “enough” percentage is a fascinating approach to determining AA. Did you pull this idea from a source or develop this on your own? How did you decide upon the shared percentages stock/bond based on percentage of funds to financial independence number?
On my own.
I made them up. I thought it was reasonable.