An equity glide path describes the changes in the asset allocation of equity investments as you age. You can use such a path to build and maintain a retirement portfolio that gives you a good balance between risk and reward.
Learn how an equity glide path works and explore the types of glide paths to decide 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 varied asset classes. This may include stocks, bonds, and cash. An equity glide path refers to key shifts in equity or stock placement in your account over time. You use your age at any given time to decide how to spread and manage the assets you will need to tap into when you retire. The type of glide path you choose will decide the percentage of equities in your account that will either increase, decrease, or remain the same as you get older and approach retirement.
How an Equity Glide Path Works
Retirement savers are urged to maintain a diverse portfolio that includes stocks, bonds, and cash. This is done to avoid giving too much weight to any given asset class and lower the risk of losing money in the market.
Still, not all asset classes carry the same level of risk. Stocks often carry more risk than bonds. This is because they may offer higher returns over the long term, but they also come with a higher risk of a decline in value in the short term. In contrast, bonds are less risky in the short term but bring lower returns in the long term. It's helpful for savers to shift their assets over time in a way that evens out risk and returns and gets them to their investment goals. Such shifts are known as equity glide paths.
For Instance, let's say that you're 25 years old and want to retire at 65. Because the time until you retire is 40 years, the things you invest in can weather the downturns and decline in value from an allocation that comes with more risk. As you steer away from more risk as you age, you opt for an asset spread that follows a declining glide path.
With this type of glide path, the amount of equities you have in your account goes down as you age. You can buy individual funds and change your portion over time to decrease the tilt toward equities in your account. Or, you can buy a target-date retirement fund, named after the calendar year in which you expect to retire. (such as Target Date 2050). These funds are usually managed in a way that the risk level goes down as you near the target date without you having to change things on your own.
This lowered risk is often done by cutting back the number of equities you have as you get closer to the target date of the fund. The fund might start with an equity spread of 95% at age 25 but then drop to 75% by age 45 and 50% by age 65. This is done by trading stock for less risky investments over time.
When you decide where to put your assets, think about your glide path along with the amount of income you will need to take out when you retire. A higher withdrawal rate might demand a more zealous equity allocation to get the growth you'll need.
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 slowly reduce your spread 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 amount of equities as the y-axis, the line would have a negative slope. The “100 minus your age” rule of thumb is one way to look at a declining glide path.
This rule of thumb says that to figure out how much you should have in equities — stocks or stock index funds — you should subtract your current age from 100. For instance, at age 60, you would have 40% of your funds in stock equities, with the rest in safer asset classes like bonds. Each year, you would reduce your equities portion by 1% and increase that same amount to bonds.
Static Equity Glide Path
A static glide path 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 change the balance of your portfolio to return to that target spread. If you were taking money out of your account — using a systematic withdrawal approach — you would take enough from each asset class that the spread would remain at 60% equities and 40% fixed income after your withdrawal.
For instance, assume that at the start of the year, you have $100,000. You have 60% of that amount, $60,000, in a stock index fund, and 40% 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 $4,000 out of the account.
After you take out that amount, you will have a balance of $102,000 left. To maintain a 60/40 spread, you will want to have $61,200 in equities and $40,800 in bonds. Thus, you would sell $3,800 of your stock index fund and $200 of your bond fund.
Rising Equity Glide Path
A rising equity glide path is the reverse of the declining glide path. As you age, your equities portion would slowly increase as long as 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 30% in equities. You might create a bond ladder where bonds mature each year to meet the amount of money you will need to take out of the account. But the equity portion of your account might grow to around 70% over time.
Which Glide Path Is Best?
Wisdom holds that the declining glide path that calls for decreasing portfolio exposure to equities over time is most aligned with people's low risk tolerance as they age.
Still, some experts have hailed the static glide path as the best approach. Financial expert Bill Bengen, for example, has stated that a static equity spread of 50% to 75% is ideal.
Also, retirement experts Michael Kitces and Wade Pfau found that a rising glide path, such as one starting with 30% in equities and going up to 70% over 30-years, yields better outcomes than a static or declining glide path.
Aside from research, there is no way to know in advance which type of glide path will bring you the best outcome for the market ups and downs you will meet when you retire. Your best option is to assess the time you have until you retire, tolerance for risk, and investment goals, and then pick the approach that suits you best and maintain it in a careful way.
- An equity glide path refers to the changes to the equity portion of your asset allocation over time.
- You can buy individual funds and watch your spread over time to create an equity glide path or buy target-date funds for a hands-off approach.
- The main types of glide paths are declining, static, and rising, where the equities portion of the allocation goes down, remains stable, or goes up over time, respectively.
- The right glide path depends on the time you have to invest, how much risk you can take, and your retirement goals.