Using Glide Path Formulas for Asset Allocation Strategies
The "glide path formula," in terms of investing, refers to the methodology by which the asset allocation of a portfolio changes 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.
What Is a Glide Path Formula?
Glide path 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 mutual fund. The target date is typically a year that represents a particular date or decade in which an investor expects to reach their objective, such as retirement.
Types of Glide Path Formulas
There are three major types of glide paths typically used in determining an appropriate asset allocation for an investment portfolio: Static Glide Path, Declining Glide Path, and Rising Glide Path. Here's how each glide path formula works:
Static Glide Path
With this glide path, the investor uses the same target asset allocation but will periodically rebalance the portfolio to return to the target allocations.
For example, a common moderate allocation is 65 percent stocks and 35 percent bonds. During most calendar years, stocks will outperform bonds, which will skew the allocation toward stocks by the end of the year. At this time, the investor will place the appropriate trades to return the allocation to the original target of 65 percent stocks and 35 percent bonds.
Declining Glide Path
This glide path formula is common with target-date retirement funds, where 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. Therefore, a 30-year-old investor would have an asset allocation of 70 percent stocks and 30 percent bonds. With longer life expectancy today, a more common formula is 100 - Age + 14 = Stock Allocation. Using this formula, a 30-year old investor would have an allocation of 84 percent stocks and 16 percent bonds. At age 31, the allocation would be 83 percent stocks and 17 percent bonds.
Rising Glide Path
The least common glide path, this formula would begin with an allocation more heavily weighted to bonds and would shift more to stocks as the bonds mature. For example, an allocation of 65 percent bonds and 35 percent stocks might change to 65 percent stocks and 35 percent bonds. As the bonds mature, the investor would purchase equities in the portfolio.
Using Glide Path With Target-Date Retirement Funds
The easiest way to apply the glide path strategy is to buy a target-date retirement fund. For example, an investor choosing a target-date 2050 fund expects to retire between the year 2050 and 2060.
Since target-date retirement funds are designed to maintain an allocation appropriate for the target year or decade, the asset allocation will need to shift toward a more conservative mix gradually.
A typical target-retirement 2050 fund may have an asset allocation of roughly 80 percent stocks and 20 percent bonds. But as the target year approaches, stocks will receive a steadily declining allocation and bonds will receive a steadily increasing allocation. Cash can also become part of the allocation, especially as the target date draws closer.
Reach Your Investment Goals With 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. Since stocks have greater market risk than bonds, it's wise to decrease exposure to stocks as the time horizon of the objective nears its end. In this common application, a declining glide path can make sense for the investor.
Gliding path formulas can prevent investors from attempting to time the market and invest according to market conditions. Since market timing tends to do more harm than good concerning portfolio returns, the glide path formula can be a wise tool for long-term investors.
Pracekladno does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.