Definition and Example of Glide Path Formula
How to Calculate Glide Path Formula
How Glide Path Formula Works
What Are the Benefits of Glide Path Formulas?
What Are the Limitations of Glide Path Formulas?
Definition and Example of Glide Path Formula
The glide path formula is a method for calculating how asset allocation in an investment portfolio changes over time. The formula typically uses the investor’s age or target year to help determine an appropriate mix of stocks, bonds, and cash.
Most glide path formulas reduce exposure to equities as the target age or target year approaches. There is no precise formula for your age or time until retirement, but understanding the basic ways you can use glide path formulas will help you plan your strategy.
For example, you can use a glide path formula for your expected retirement date. The declining version of the glide path formula will use your current age and retirement date to determine the stock versus bond allocation in your investment portfolio.
How to Calculate Glide Path Formula
There are three main types of glide paths used to find the appropriate asset allocation for an investment portfolio: static glide path, declining glide path, and rising glide path. Here’s how each type works.
1. Static Glide Path
With this glide path, you use the same target asset allocation but periodically rebalance the portfolio to ensure that it remains aligned with those target allocations.
For example, a common allocation is 65% stocks and 35% bonds. Over most years, stocks will outperform bonds. This will lead to a tilt toward equities by the end of the year. At that time, you can make the necessary trades to rebalance back to the original target of 65% stocks and 35% bonds.
2. Declining Glide Path
This glide path formula is common in target-date retirement funds. A target year or target date is used in the formula to determine the asset allocation.
One classic glide path formula is:
Let’s say you are 30 years old. This means you have an asset allocation of 70% stocks and 30% bonds, but we have longer life expectancy forecasts today. The most common formula is:
Now, let’s use this formula. If you are 30 years old, you would have an allocation of 84% stocks and 16% bonds. Upon turning 31, it would change to 83% stocks and 17% bonds.
3. Rising Glide Path
This is the least common glide path. The formula starts with a heavier bond allocation; it will shift to more stocks as bonds mature. For example, let’s say you start with a distribution of 65% bonds and 35% stocks. That may change to 65% stocks and 35% bonds.
As the bonds mature, you will buy securities in the portfolio. Some advisors recommend this approach as a way to protect against significant losses during the early years of retirement.
How Glide Path Formula Works
What’s the easiest way to implement a glide path strategy? Buy a targeted retirement investment fund. For example, let’s say you expect to retire between 2050 and 2060. You might choose a retirement fund for the year 2050.
Target-date retirement funds aim to maintain an appropriate allocation for the target year or target date. The assets will need to gradually shift toward a more conservative mix if you are using a declining glide path strategy.
A target retirement fund for 2050 might have an asset allocation of about 80% stocks and 20% bonds. But as the target year approaches, stocks will receive increasingly declining allocations. At the same time, bonds will receive increasing allocations. Cash can also become part of the mix, especially as the target date nears.
What
What are the benefits of glide path formulas?
Investing using glide path formulas can be a straightforward and strategic way to blend passive and active management to achieve investment goals. Stocks carry greater market risks than bonds, so it is often wise to reduce exposure to equities as the time horizon of the goal approaches its end. From this perspective, a downward glide path formula can make sense.
Glide path formulas can prevent investors from trying to time the market and invest according to market conditions, but market timing tends to inflict more harm on portfolio returns than good. This means that a glide path formula can be a prudent tool for long-term investors.
What are the limitations of glide path formulas?
Be cautious not to rely on a single glide path formula for success. Investment strategy largely depends on your age, long-term goals, and market factors. It may be beneficial to talk to a financial advisor when considering any changes in asset allocation before or during retirement.
Source: https://www.thebalancemoney.com/glide-path-formula-definition-and-example-4582110
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