The glide path formula is a method for calculating how the asset allocation of an investment portfolio should change over time. The formula typically uses the investor's age or a target year to help determine an appropriate mix of stocks, bonds, and cash.
Most glide path formulas reduce exposure to stocks as targeted age or year approaches. There is no exact formula for your age or time until retirement. But knowing the basic ways you can use glide path formulas will help you plan your strategy.
What Is a Glide Path Formula?
The glide path formula is the name of a method or strategy used for calculating the asset allocation for investment portfolios or target-date mutual funds. The asset allocation is the percentage mix of stocks, bonds, and cash in the portfolio or fund. The target date is often a year, decade, or date in which an investor expects to reach their objective. For instance, it could be when you plan to retire.
When investing using a target-date fund, the shift in asset allocation over time is simply called the fund's "glide path."
How Do You Calculate the Glide Path Formula?
There are three major types of glide paths used in finding the right asset allocation for a portfolio: Static Glide Path, Declining Glide Path, and Rising Glide Path. Here's how each type works.
1. Static Glide Path
With this glide path, you use the same target asset allocation. But you will likely rebalance the portfolio from time to time in order to return to the target allocations.
For instance, a common allocation is 65% stocks and 35% bonds. During most years, stocks will outperform bonds. This would skew the allocation toward stocks by the end of the year. At this time, you could place the trades needed to return the allocation to the original target of 65% stocks and 35% bonds.
2. Declining Glide Path
This glide path formula is common with target-date retirement funds. This is when a target year or decade is used in the formula to determine the asset allocation.
A classic glide path formula is:
100 - Age = Stock Allocation
Let's say you are 30 years old. That means you would have an asset allocation of 70% stocks and 30% bonds. But people have a longer life expectancy today. A more common formula is:
100 - Age + 14 = Stock Allocation
Now, let's use this formula. If you were 30 years old, you would have an allocation of 84% stocks and 16% bonds. At age 31, it would change to 83% stocks and 17% bonds.
3. Rising Glide Path
This is the least common glide path. This formula would begin with an allocation more heavily weighted to bonds; it would shift more to stocks as the bonds mature. For instance, let's say you start with an allocation of 65% bonds and 35% stocks. This might change to 65% stocks and 35% bonds.
As the bonds mature, you would purchase equities in the portfolio. Some advisors suggest this method as a way to guard against large losses during the early years of retirement.
How the Glide Path Formula Works
What is the easiest way to apply the glide path strategy? Buy a target-date retirement fund. For instance, let's say you expect to retire between the years 2050 and 2060. You might choose a target-date 2050 fund.
Target-date retirement funds are meant to maintain an allocation appropriate for the target year or decade. This means the assets will need to shift gradually toward a more conservative mix if you are using a declining glide path strategy.
A typical target-retirement 2050 fund may have an asset allocation of roughly 80% stocks and 20% bonds. But as the target year draws closer, stocks will receive a steadily declining allocation. At the same time, bonds will receive an increasing allocation. Cash can also become part of the mix. This is even more true as the target date draws closer.
What Are the Benefits of Glide Path Formulas?
Investing with glide path formulas can be a simple, strategic way of combining passive and active management to reach an investment objective. Stocks have greater market risk than bonds. So it's often wise to decrease exposure to stocks as the time horizon of the objective nears its end. In this way, a declining glide path can make sense.
Glide path formulas can prevent investors from attempting to time the market and invest according to market conditions. But market timing tends to do more harm than good concerning portfolio returns. That means the glide path formula can be a wise tool for long-term investors.
What Are the Limitations of Glide Path Formulas?
Be careful not to rely on a single glide path formula for success. Investing strategy depends so much on your age, long-term goals, and factors in the market. It may be helpful to talk to a financial advisor as you consider any changes in asset allocation before or during retirement.
- Glide path formulas are used for calculating changes in asset allocation in an investment portfolio over time.
- There are three types: static glide path, declining glide path, and rising glide path.
- The type of formula you use depends on how close you are to retirement (or how far into it you are), how much you have saved, and your comfort level with risk.
- This method is commonly used with target-date mutual funds.