Glide paths and the significant role they play on target-date funds

What are glide paths?

Is there something that can define an asset allocation mix of funds that has a target date? The answer is yes, and it is a formula that we call the ‘Glide Path.” It depends on the number of years to the target date. This formula makes an asset allocation that will more or less become more conservative in the long run as it gets nearer to the target date. When we say “more conservative,” we mean that there will be more fixed-income assets while equities will become lesser.

Target date funds and glide path

A glide path plays a significant role in a target-date fund. Target date funds are the ones that investment companies offer. These funds aim to grow more as they reach the target goals like retirement. In the long run, they automatically become more conservative. Target date funds fall under different kinds of families. And for every family comes different glide paths. As we have mentioned, these glide paths are the ones that determine the way the asset mix changes as the target date gets closer. While some may have a steep or high trajectory, others have a slow and gradual one. It will become highly conservative a few years closer to the target date when the trajectory is steep.

As we reach the target date, the asset mix will also be different. Why? Some funds automatically assume that some people are interested in massive safety and liquidity because they want to use those funds to buy annuities as they retire. On the other hand, some of these funds may think that other investors hold onto them and have more additional equities in the pool of asset mix. Thus, it reflects that they are looking at a longer time horizon.

Different types of glide paths

Let us learn the brief differences and classification of glide paths:

  • Declining glide paths. The allocation gradually reduces equities for every year it gets close to retirement.
  • Static glide path. The allocations remain constant and maintained.
  • Rising glide path. This approach contains more bonds than equities in the beginning. As the bond matures, the equity allocation increases. This is possible as long as the stocks’ value inside the portfolio does not decline.

Who are the ones who typically engage with target-date funds?

The answer goes to those who are preparing to retire. Target date funds became so popular to them because they are based on an idea. This idea is about age and time. Younger investors have more time horizons before retirement. It also means these younger investors have more risks that they can take. Thus, the longer the time horizon they have, the more expected returns they can have accordingly.

If you look at a younger investor’s portfolio, it is not uncommon to see that it contains many equities. On the other hand, older investors would be more conservative with their portfolios. They will have fewer equities and more fixed-income investments. It goes to show that age has a lot of influence over an investor’s portfolio.