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Retirement income: Tracking the glide path discussion

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The debate over the appropriate allocation of a retirement portfolio has been going on for years.

While rules-of-thumb such as “100 minus your age in equities” were once the standard guidance, the popularity of target date funds has animated the discussion in recent years.

The lack of a precise allocation formula among funds has led to debate over the glide path, i.e., how the equity versus fixed income allocation should be adjusted as the targeted retirement date approaches. Funds with steep glide paths shift to more conservative fixed income holdings quickly as the target date nears while other funds take a smoother approach. 

The glide path discussion continues to generate interesting research. Here is a summary of several recent articles that are worth reading in full. I provide the articles’ titles and authors’ names; a Web search will provide the papers’ online locations. 

Glide Path Caution! A Steep Slope Could Derail Retirement Income Success

Authors: E. Iantchev, M. Jensen, S. O’Toole (Fidelity Investments)

Key findings: 

The probability of recovering from a major cyclical equity market decline during the pre-retirement years is higher for gradual sloped glide paths—which typically hold higher equity exposure—than for steep-sloped glide paths.

In a glide path comparison of steeper “To” and more gradual “Through” slopes during the five-year period before retirement, our analysis showed an investor’s wealth being greater in a more gradual- sloped “Through” glide path in a significant majority of simulated market environments.

 

Reducing Retirement Risk with a Rising Equity Glide Path

Authors: W. Pfau, M. Kitces (Journal of Financial Planning)

Key findings:

Results show, surprisingly, that rising equity glide paths in retirement—where the portfolio starts out conservative and becomes more aggressive through the retirement time horizon—have the potential to actually reduce both the probability of failure and the magnitude of failure for client portfolios.

Overall, the results show that rising equity glide paths from conservative starting points can achieve superior results, even with lower average lifetime equity exposure. For instance, a portfolio that starts at 30 percent in equities and finishes at 60 percent performs better than a portfolio that starts and finishes at 60 percent equities. A steady or rising glide path provides superior results compared to starting at 60 percent equities and declining to 30 percent over time.

Retirement Risk, Rising Equity Glide Paths, and Valuation-Based Asset Allocation

Authors: M. Kitces, W. Pfau (Journal of Financial Planning)

Key findings:

Based on U.S. historical data, it is difficult to beat a strategy that maintains a consistently high allocation to stocks to the extent that a retiree’s risk tolerance allows for this, and subject to the caveat that high stock allocations cannot always be expected to do as well in the future. 

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However, when retirements beginning in varying valuation environments are considered, the potential for different dynamic allocation strategies emerge to help retirees sustain higher spending levels with lower average stock allocations.

When retirements begin in overvalued market environments (which reflected the situation for new retirees in 2015), an accelerated rising equity glide path shows potential to provide downside risk protection for retirees. In other valuation environments, historical worst-case scenario sustainable withdrawal rates are highest with valuation-based asset allocation strategies.

Revisiting the Optimal Distribution Glide Path

Author: D. Blanchett (Journal of Financial Planning)

Key findings: 

Debate continues regarding how an investor’s equity allocation should change during retirement. This study tests four different changing equity glide path shapes: increasing, decreasing, V-shaped, and -shaped contrasted against the potential benefit of a constant glide path.

The decreasing glide path was found to be the optimal glide path shape across a wide range of scenarios based on the analysis; however, results showed no clear, one ideal glide path shape for each retiree scenario. 

The increasing glide path was noted to be the least efficient, and the V and shapes fell in the middle.

The decreasing glide path resulted in approximately 2.0 percent more utility-adjusted overall potential wealth compared to a constant glide path; the increasing glide path resulted in a 2.7 percent overall potential wealth decrease.

Retiree risk tolerance was not explicitly considered in this analysis. If it was, the decreasing glide path would likely become even more attractive.

Target-Date Glide Paths: Balancing Plan Sponsor Goals

Authors: R. Fullmer, J. Tzitzouris (T. Rowe Price)

Key findings:

We find that higher-equity glide paths are better at providing an income stream that enables participants to maintain their standard of living through retirement. This result is robust for both broad and narrow definitions of tail risk.

Conversely, a lower-equity glide path might be a better choice for plan sponsors who are concerned about participants’ ability to recover their peak account balance in the early stages of retirement and who are willing to trade some lifetime income potential for lowering the risk of significant capital loss near retirement.

Because no one glide path can simultaneously satisfy both goals optimally, a compromise is required, and thus the selection process must be informed by the subjective horizon and risk preferences of the sponsor acting as an agent for plan participants.