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That’s the approach taken by Target Date Funds and traditional financial planning. Does that make sense for you?
William Bernstein, MD is often quoted and paraphrased, having stated that you ought to stop playing once you’ve won the game. In other words, once your financially independent and beyond, why invest substantially in potentially risky assets like stocks?
However, and he said it himself at WCICon18, if you’ve won the game 2 or 4 times over, having a withdrawal rate of 1% or 2%, you can live with that volatility and be invested in 100% stocks with little risk. The biggest risk then is that you may have an estate tax “problem” if you don’t start spending more or giving it away.
That sentiment aligns well with my risk preference. I’d just as soon have enough money in my portfolio to remain invested aggressively with a reverse glidepath as Big ERN discusses in his SWR series. If I might live another 50 or 60 years, that’s a long time to have money on the sidelines playing it safe.
Let’s see what Dr. Jim Dahle has to say about allocation glide paths. This post was written by him and originally published at The White Coat Investor.
How to Design Your Personal Retirement Glide Path
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.
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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!
10 thoughts on “How to Design Your Personal Retirement Glide Path”
Asset Allocation is a popular & a Interesting Topic –
My take was conventional, started at 80/20 Stocks/Bonds when starting as a Attending & gradually down presently to 55/45.
I am 63 & Wife is 58, I am on a disability income (Non Taxable) for 2 more years before I retire with no income apart from the income from the investments. I volunteer at a free clinic & Wife stays at home. The net worth has grown exponentially to $7 m, thanks to regular saving & the long Bull Market
In an effort to dampen the tax hit from the income from RMDs & Social Security starting at age 70 1/2 combined with the dividends from the taxable accounts, I have started & will continue the Roth conversions.
I have all the bond funds in Tax Deferred & Stocks in Taxable accounts & my Portfolio will become aggressive back again as I convert the Bonds from the Tax Deferred to Stock funds in the Roths. This may also dampen the effect of sequence of return risk when applied with dynamic spending rate.
Funds in the Roth can be used during the far end of our lives or left behind as inheritance. A immediate Annuity may also be considered at age 70.
Good Luck wishes to early retirees
It’s a great post because a lot of folks seem fixated on being all in all the time. After several years of retirement and turning 60 last summer I went with a new allocation thinking about “you ought to stop playing once you’ve won the game”. Running my numbers through a Monte Carlo Calculator showed I could easily reduce portfolio risk, so I took profits from stocks to change allocation to –
18.5% Cash/Cash Investments
29.5% Bonds Fixed Income
48% Equities
4% Alternatives
Aside from the mechanics of allocation adjustment as we age in retirement, I think there’s also a psychological side to investing that starts to appear. I just felt better about the new portfolio direction. One that years earlier wouldn’t have crossed my mind.
I think a lot of people are overly aggressive after years of good returns. Everyone will become a lot more conservative after we hit a big bump.
My target is 60/40 for now. I will probably change it to be more aggressive once the market looks cheaper. We’re still young so our portfolio has plenty of time left.
Great article. Would like to add #8. “How stable is your employment”. Seems to me the less likely you are to lose your job, the more risk you should assume with your assets. For example. You work for a government agency in which no one has ever been fired in the history of the agency. Your investments should skew towards more risk. OTOH let’s say you are the fourth doc in eight years to be hired with a one year contract at a hospital on shaky financial grounds. Might want to skew towards less risky. This is similar to thinking one needs one year of living expenses in cash, but a different approach. To be more succinct, the more stable your income stream, the more risk in your investments, and vice versa. It runs counter in some ways to the idea of always being all in when young, but it makes sense to me, especially if your future is shaky.
if you use a monte carlo simulator where you can enter sequence of risk for 1-5 years you will see the probability of outliving your assets declines dramatically
the goal in retirement is not to look to gain the highest absolute return; it is to maintain lifestyle and preserve capital
Such a topic to ruminate on…
It’s always bothered me that WCI didn’t have a plan for a glide path but I understand his current reasonableness. I worry though that his belief of big jumps would be a poor plan for many and would lead to defacto timing of the market. But I’m not sure I have a better plan myself.
I think a more effective approach is to maintain a deep and wide moat of cash enabling the funding of about 3 to 5 years of anticipated expenses. Allow this cash to freely flow in and out of a portfolio of equities, ETFs, REITs but no bonds at all. The portfolio is then re-balanced in intervals of every 135 to 185 days such that once a re-balancing interval is activated a portion of the portfolio is gradually re-balanced every 8 business days over a 60 day interval such that if any single holding is up more than 11% that position is partially sold and if any single equity holding is down more than 7%, cash is deployed into that holding. If these thresholds are not met, no trading occurs (unless there is more than 5 years of cash held in the portfolio or if the cash position approaches less than 3 years). If no sell or buy activity occurs during the 60 days review interval then the next review interval is reset to 135 days. If trading activity occurred then the next review interval is reset to 185 business days.
For each individual holding measuring performance from one “snapshot” to another is a weighted average of 20% of current valuation divided by 200-day moving average + 30% of valuation relative to original valuation from the beginning of the portfolio inception + 50% of valuation relative to the last “snapshot” review. The actual trigger buy/sell event may be modified slightly when an equity is about to issue a dividend so as to capture that opportunity.
The goal is not to fully rebalance the portfolio necessarily to the original weighting but to allow holding overweights and underweights to freely fluctuate within set ranges minimizing the effects of downside momentum and capturing upside momentum.
This methodology allows for gradually selling towards the end of a bull market and gradual buying into a bear market. You “dollar cost average” in/out of positions while accepting a degree of volatility through the cash position in the portfolio.
By keeping a deep and wide cash moat, portfolio performance can be measured over longer intervals of time dampening the effect of volatility.
Another similar way to look at this problem is with a Bond Tent.
Kitces notes that the larger your portfolio is, the more bonds (and equivalents) can be used as a “volatility dampener.”
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Dr Wade Pfau has done extensive research on the reverse glide path. That seems to be the best of both worlds wrt reducing sequence of returns risk and then having the portfolio grow aggressively. Most likely that would be my preferred approach.