Glide Path Meaning
The glide path is a plan that involves making systematic adjustments to the asset allocation of an investor’s portfolio. Its purpose is to optimize returns and manage risk as an investor nears a particular time horizon, for example, retirement or a certain target date.
Essentially, it is a plan to make an aggressive investment portfolio more conservative over time by including more fixed-income assets while reducing equity. The target date varies; it may be a decade, year, or any date on which the person expects to fulfill the objective. There are different types of glide paths, like static and rising glide paths.
Table of contents
- The glide path refers to a plan based on which the asset allocation of an investment portfolio or a target date fund alters as time passes and retirement approaches.
- This concept is of three types which are static, declining, and rising. One may choose which one is suitable for their requirement after evaluating their risk appetite, financial goals, and investment period.
- There are various advantages of this concept. For example, helps one manage risk systematically and offers customizability.
- It has drawbacks, like inaccurate assumptions and the lack of suitability for all investors.
Glide Path Explained
The glide path refers to the alteration taking place in the asset mix of any target date fund or an investor’s portfolio over time. Such plans offer a framework to manage the transition to a low-risk investment strategy from a high-risk one. One must note that the allocation percentages typically depend on the investor’s financial goals, investment time horizon, and risk appetite.
As individuals approach retirement, generally, they require an investment strategy associated with lower risk even more. This is because such persons have less time to make a recovery following market downturns compared to the time they had when they were young.
Glide paths vary from one category of target-date fund to another. They determine how a fund’s asset mix alters as its target date approaches. While a few target-date funds become significantly more conservative some years before the target date, others adopt a gradual approach. Note that the asset allocation percentages can also be significantly different on the target date.
Some of these funds assume investors seek high liquidity and safety as they might utilize the money to buy an annuity at the time of retirement. Other funds assume investors hold onto their money and include more equity in the investment portfolio. This reflects a longer investment time horizon.
Factors Impacting Glide Path Design
Some factors impacting the alterations are as follows:
- Risk Tolerance And Investment Goals: The asset mix of an investment portfolio typically depends on investors’ financial goals and risk appetite.
- Market Conditions: One must plan the alterations based on the market conditions to ensure the asset mix is right for the person’s changing requirements.
- Fees And Expenses: Higher investment-related fees and expenses can minimize investors’ returns and may require them to opt for a high-risk strategy to fulfill their retirement goals. On the other hand, lower expenses and fees may enable one to adopt a more low-risk strategy while still fulfilling identical retirement goals.
- Investment Time Horizon: Investors having longer investment time horizons might be able to bear more risk and benefit from a strategy that is more aggressive. That said, persons with short-term investment horizons may have to minimize portfolio risk exposure, switching to a conservative investment strategy.
The different types of glide paths are as follows:
#1 – Rising
This one is uncommon. It involves gradually increasing the exposure to securities associated with high risk over time. For example, let us say that an asset mix comprised 70% debt securities and 30% equity. It gradually changed to 60% equity and 40% debt securities over a duration of 8 years.
Typically, such a plan is unsuitable for investors approaching retirement, as it means higher financial risk with time. Moreover, a target date fund with this plan has a high chance of not achieving the target goal.
#2 – Declining
Out of the three types, this is the most common one. Any target date fund with this plan slowly reduces the exposure to securities carrying high risk with time. In effect, such a plan minimizes the risk of a target date fund or an investment portfolio with time.
#3 – Static
Contrary to the other two types, this one has the same asset mix over time. In other words, no change to the asset allocation percentages occurs in this case. Note that if any deviation occurs in the allocation percentages due to alterations in the underlying financial securities’ market values, the portfolio is rebalanced, and the initial asset allocation is restored.
Rule Of 100
A few target date funds may utilize a concept known as the Rule of 100 for determining this type of plan. This concept involves subtracting an investor’s age from 100 to figure out the optimal stock allocation. Hence, for example, Ronald, who is 45, will have an asset mix of 55% equity and 45% debt securities per the Rule of 100.
Let us look at a few glide path examples to understand the concept better.
Suppose David, who is 30, is seeking a target date fund in which he can invest a part of his savings. He plans on retiring when he turns 60 in 2053. There are two funds available having a 2053 retirement goal. Their descriptions are as follows:
This fund’s glide path maintains 70% equity exposure until 20 years prior to 2053. After this period, the equity allocation percentage will reduce to 20% and remain static till retirement.
In this case, the plan involves maintaining an equity allocation percentage of 50% until the target date.
David indicated that he is comfortable with a higher risk now. That said, as retirement nears, he would want reduced portfolio risk. Hence, he opts for the first fund, which has a declining glide path.
Suppose Jim is an investor who wants to invest his money in a target date fund to build a corpus that can help him meet his financial requirements post-retirement. After assessing his investment objectives, risk appetite, and investment time horizon, he opted for a fund with a static glide path approach as he was comfortable with its equity and debt asset allocation percentages of 50% each. Another reason for the selection is that he prefers having the same strategy throughout instead of transitioning from one investment strategy to another.
Pros And Cons
Let us look at the benefits and limitations of the glide path concept.
- It aids in systematic risk management.
- Such a plan can offer a clear framework to oversee the investment portfolio. Moreover, the framework can help individuals remain disciplined.
- Investors can customize the plan per their requirements to ensure the retirement objectives align with their investment strategy.
- It is based on assumptions concerning future market conditions. Such assumptions may not be accurate.
- Changes in investor behavior or market conditions can affect the glide path approach.
- It might be unsuitable for investors with complex needs or individuals requiring more personalized investment strategies.
Frequently Asked Questions (FAQs)
It helps identify the perfect balance between risk and return. Precisely, it is the point where potential return and risk align with an investor’s financial goals and risk appetite while offering adequate assets to fulfill their spending objectives until retirement.
Individuals can create it by following these steps:
1. Assess financial goals
2. Consider risk appetite and investment duration
3. Factor in the fees and expenses
4. Choose the type of glide path that aligns with the above four factors impacting the investment plan
One of the easiest ways to create it is by applying the Rule of 100.
It refers to a graph showing how the allocation percentages of stocks and debt securities in an investment portfolio change with time. Note that it involves plotting the equity allocation as a sequence of dots.
This article has been a guide to Glide Path and its meaning. We explain how it works in investing, examples, types, rule of 100, pros & cons, & factors impacting it. You may also find some useful articles here –