An equity glide path describes the changes in the asset allocation of equity investments as you age. Individuals can use such a path to build and maintain a retirement portfolio that achieves the optimal balance between risk and reward.
Learn how an equity glide path works and the different types of glide paths to determine which one is right for your retirement goals.
What Is an Equity Glide Path?
A glide path refers to changes over time in the spread of money in a portfolio across different asset classes, including stocks, bonds, and cash. Similarly, an equity glide path refers to strategic shifts in the allocation of equities or stocks in a portfolio over time. It's used as an age-based asset allocation approach for managing a retirement portfolio. Depending on the type of retirement glide path, the percentage of equities in a portfolio will either increase, decrease, or remain relatively stable as you age and approach retirement.
How an Equity Glide Path Works
Retirement savers are urged to maintain a diversified portfolio including stocks, bonds, and cash to avoid overweighting any given asset class and minimize the risk of losing money in the market. But not all asset classes carry the same level of risk. Stocks are riskier than bonds generally, as they hold the potential for higher returns over the long term but also higher volatility and resulting declines in value in the short term. In contrast, bonds are less risky in the short term but yield moderate returns in the long term. It's advantageous for savers to shift their asset allocation over time in a way that balances risk and returns and achieves their investment objectives. Such shifts are known as equity glide paths.
For example, let's say that you're 25 years old and want to retire at 65. Because your time horizon is 40 years, your portfolio can weather the occasional downturn and decline in value from a higher-risk allocation. But as you expect to grow more risk-averse as you age, you opt for an asset allocation that follows a declining equity glide path. With this type of retirement glide path, your exposure to equities decreases as you age. You can buy individual funds and change your allocation manually over time to decrease the tilt toward equities in your portfolio. Or, you can buy a target-date retirement fund, named after the calendar year of your expected retirement (such as Target Date 2050), as these funds are usually managed in a way that the risk level decreases as you near the target date without your intervention.
This decreasing risk is typically accomplished by decreasing the allocation to equities as you get closer to the target date of the fund. The fund might start with an equity allocation of 95% at age 25 but then drop to 75% by age 45 and 50% by age 65 by trading stock for less risky investments over time.
When establishing your asset allocation, consider your equity glide path alongside your expected income withdrawal rate in retirement. A higher withdrawal rate generally demands a more aggressive equity allocation to maximize growth.
Types of Equity Glide Paths
There are main three main types of glide paths.
Declining Retirement Equity Glide Path
A declining equity glide path is where you gradually reduce your allocation to equities as you get older. If you were to plot this path on a line graph, with age as the x-axis and the percentage of a portfolio in equities as the y-axis, the line would have a negative slope. The “100 minus your age” rule of thumb is an example of a declining equity glide path.
This rule of thumb says that to determine how much you should have allocated to equities—stocks or stock index funds—you should subtract your current age from 100. For example, at age 60, you would have 40% of your invested funds in stock equities, with the remainder in safer asset classes like bonds. Each year, you would reduce your allocation to equities by 1% and correspondingly increase your allocation to bonds.
Static Equity Glide Path
A static glide path to retirement would be an approach where you maintain a specific strategic asset allocation, such as 60% to equities and 40% to bonds. Each year, you would rebalance your portfolio to return to that target allocation. If you were taking withdrawals—using a systematic withdrawal approach—you would take enough from each respective asset class that the allocation would remain at 60% equities and 40% fixed income after your withdrawal.
Using an example, assume that at the beginning of the year, you have $100,000; 60% of it—$60,000—is in a stock index fund, and 40% is in a bond index fund. By the end of the year, assume the stock index fund is now worth $65,000, and the bond index fund is worth $41,000. Now, assume you need to take a $4,000 withdrawal.
After your withdrawal, you will have a balance of $102,000 left. To maintain a 60/40 allocation, you will want to have $61,200 remaining in equities and $40,800 in bonds. Thus, you would sell $3,800 of your stock index fund and $200 of your bond fund.
In reality, you would likely not place a trade to sell $200 of your bond fund—you might just take the full $4,000 out of the stock index fund, as $200 becomes an insignificant amount relevant to the size of the portfolio, and can help cover trading costs. It's used here for the sake of illustrating how to maintain a static equity glide path.
Rising Equity Glide Path to Retirement
A rising equity glide path is the reverse of the declining glide path: As you age, your allocation to equities would gradually increase, assuming they earned a positive rate of return. Such a path would produce a line with a positive slope when plotted on a line graph.
This might be an approach where you start with a larger portion in a low-risk asset class like bonds—perhaps 70%, and another 30% in equities. You might create a bond ladder where bonds mature each year to meet your needed withdrawal amounts. But the equity portion of your account might grow to around 70% over time.
Which Equity Glide Path Is Best?
Conventional wisdom holds that the declining equity glide path that calls for decreasing portfolio exposure to equities over time is most aligned with people's decreasing tolerance for risk as they age.
However, some experts have hailed the static equity glide path to retirement as the best approach. Retired financial advisor Bill Bengen, for example, posited that a static equity allocation of 50% to 75% is ideal.
In addition, retirement researchers Michael Kitces and Wade Pfau found that a rising equity glide path, particularly one starting with 30% in equities and increasing to 70% over a 30-year period, yields better retirement outcomes than a static or declining equity glide path.
Research notwithstanding, there is no way to know, in advance, which type of equity glide path will deliver the best outcome for the economic and market conditions you will encounter in your retirement years. Your best option is to assess your retirement time horizon, tolerance for risk, and investment goals (such as capital appreciation or income), and then pick the allocation approach that suits them and maintain it in a disciplined way.
- An equity glide path represents the changes to the equity portion of your asset allocation over time.
- You can buy individual funds and reassess your allocation over time to achieve a particular equity glide path, or purchase target-date retirement funds for a hands-off approach.
- The main types of equity glide paths are declining, static, and rising, where the equities portion of the allocation decreases, remains stable, or increases over time, respectively.
- The right equity glide path depends on the time horizon, risk tolerance, and retirement goals of the investor.