Challenges to the Traditional Glide Path

A paper published in The Journal of Retirement argues that asset-allocation glide paths popularized in target-date funds (TDFs) fail to deliver superior end-point wealth.

Traditional glide paths involve a portfolio-wide shift away from equities and into fixed income as an investor approaches a predetermined retirement date. The logic is that, when an investor is young, he can afford to take on additional risk to gain better returns. An investor approaching retirement, on the other hand, has less time to recover from equity losses and should therefore favor bonds and fixed-income investments.

In “The Glidepath Illusion … and Potential Solutions,” a team of authors from Research Affiliates say this approach, while intuitive, rarely plays out in the real investing arena.

To demonstrate the point, researchers ran simulations for three different asset-allocation strategies, all assuming a 41-year career and a consistent, inflation-adjusted $1,000 annual contribution. The strategies include glide-path asset allocation, with investments shifting from 80% stocks and 20% bonds to the opposite upon retirement. Also tested were a static allocation rebalanced annually to maintain 50% each for stocks and bonds, as well as an inverse glide path shifting from fixed income to equities.  

To compare the strategies, the research team used 141 years of stock- and bond-market data to develop 101 different model investment experiences. The results show the typical glide path allocation resulted in lower ending retirement assets than either the balanced approach or the inverse glide path—even for the extreme bottom tail of the model portfolios’ distribution curves. The glide path approach consequently failed to provide a higher ending real annuity within the simulation.

Report authors explore a long list of explanations for the phenomenon. One interesting take is that, while all three asset-allocation strategies average a 50/50 stock to bond mix over an investor’s lifetime, the dollar-weighted average allocation is actually far more bond-centric within the classic glide path strategy.

The result is that, by the time investors using a target-date strategy have generated large account balances, they have already moved to fixed-income products and therefore miss the chance to put those additional dollars to work in the equity markets, where returns tend to outpace those in fixed-income markets. This is problematic when considering that stocks have significantly outperformed bonds over almost all historical periods.

Another explanation points out that any individual investor is just as likely to see good equity returns late in his career as he is to see them early. So an investor who enacts a traditional glide path during depressed equity markets may miss out on better returns later in his career, after he has already shifted towards fixed income.

A copy of the paper, authored by Rob Arnott, Katrina Sherrerd and Lillian Wu, can be downloaded here