Asset allocation glidepaths, or lifetime risk allocations, are a fundamental component of target date investing. They serve as the strategic blueprint that dictates how a fund’s asset allocation changes over time. Typically, a glidepath starts with a higher concentration of riskier assets like stocks when the retirement date is far away and gradually shifts towards more conservative assets like bonds as the target date, or the normal retirement age, approaches.
The Lifecycle Investing Framework
At any one point in one’s life, the person’s total wealth is the total value of current Financial Capital and the present value of the person’s Human Capital. Human Capital is defined as the remaining employment earnings of the person. Human Capital is more predictable than Financial Capital, and it behaves more like a fixed income or bond. Every year, a certain amount of earnings is received, like interest earned from a bond. Financial Capital is more like equities or stocks and more volatile or less consistent. Thus, when a worker is young, their wealth is primarily comprised of Human capital and little Financial capital. The portfolio should be made up of more stocks to diversify the abundance of bond like Human Capital. As one ages, one’s Human Capital wanes, which means investing more in bonds to diversify risk.
Importance of Glidepaths
- Life Cycle Investment Management: The primary purpose of a glidepath is to manage investment risk appropriately across different life stages. Early on, when an investor can afford more volatility, the glidepath allocates more to equities to maximize growth potential. As retirement nears — when income is needed, and there’s less time to recover from market downturns — the glidepath helps reduce exposure to equities, thus lowering the risk of significant losses.
- Automatic Rebalancing: Glidepaths provide a systematic approach to rebalancing, ensuring that the asset allocation remains optimal or efficient with the investor’s changing risk profile corresponding with investment time horizon. This automation relieves investors from the need to manually adjust their portfolios, which can be a complex and emotionally driven process.
Why Personalize Glidepaths
While traditional TDFs use standardized glidepaths based on age bands (e.g., five-year increments), there’s a growing affinity for personalizing them because:
- Individual Circumstances Vary: Not all investors of the same age have the same life circumstances, risk tolerance, financial situations, or retirement goals. For example, two individuals planning to retire at 65 may have vastly different savings rates, employer contributions, earnings, and retirement savings, which could seriously influence how much risk each should take.
- Customization Can Enhance Outcomes: By tailoring the glidepath to each individual’s needs and circumstances, personalized TDFs can provide more prudent portfolio through better risk alignment. This customization can improve investment satisfaction and outcomes by better optimizing risk-return trade-offs over time for each investor.
- Dynamic Adjustments: Personalized glidepaths can dynamically adjust not just for age but also for changes in an individual’s life situation, market conditions, and economic outlook. This flexibility allows the investment strategy to remain relevant throughout the investor’s life, adapting to factors that a traditional age-factor-only glidepath does not consider.
In conclusion, while traditional TDFs with standard age bands have made investing for retirement simpler and more accessible, the next evolution towards personalization acknowledges that one size does not fit all. By considering a broader range of unique variables, personalized glidepaths aim to provide a more nuanced aligned approach to retirement investing.