Google glide path, and, once you’ve gotten past an airplane’s descent and some logistics and industrial businesses, you’re likely to land on the concept of the changing asset allocation of a target-date mutual fund. But if you think you’ve found pay dirt, you may be getting shortchanged. Many of the search results that seek to explain this type of glide path will begin and end with a stock/bond dichotomy. As you glide toward retirement, the target-date fund’s stock allocation does indeed decrease while its exposure to bonds goes up. But this is only part of the story for glide paths.
There are more than two paths you can go by
This conventional and simplified view of an investing glide path conceals the significant roles played by sub-asset classes that target-date funds can use to calibrate risk and opportunity carefully on the way to—and through—an investor’s retirement. After all, stocks and bonds come in a wide spectrum of flavors, from high beta to defensive, and different parts of the spectrum are more relevant and useful at various degrees through the course of a long-term investment. Alternative assets may offset correlations between the primary asset classes and may provide risk mitigation in the event of market downturns.
Standard glide path: equity holdings descend as retirement nears (%)
Portfolio in equities
Source: Manulife Investment Management, 2/26/21. For illustrative purposes only. Not indicative of any fund.
We’ve prepared a white paper to guide you through a collection of glide paths that may define an approach to target-date portfolio construction. The paper first outlines the asset class components and their specific benefits for investors at different life stages. It goes on to divide the parent glide path into discrete phases in which we describe the interplay of the asset class components. We review the initial development of a capital base, the subsequent periods focused on targeted accumulation with shifting risk profiles, and the eventual concentration on asset preservation and decumulation—a big word for taking out the assets that have been built over many years.
Asset classes may have two—or more—meanings
It’s easy to think of stocks as the widely recognized large-capitalization indexes, such as the S&P 500 Index,¹ and such equities do play a critical role throughout much of the overall glide path. But there are also high beta stocks, as mentioned earlier, and there are defensive equities, which may offer a degree of downside risk mitigation while seeking to provide the opportunity for participation in a rising equity environment. All these types of stocks may have their own glide paths under the cover of the broad equity classification. In other words, when the equity versus fixed-income allocation becomes more conservative as the glide path derisks, the underlying asset class mix under the hood of the glide path should also shift. The equity composition may offer a greater level of risk mitigation as the investor approaches retirement and then enters the decumulation phase.
The same goes for fixed-income securities. High-quality bonds are essential to the capital preservation aspect of many long-term investment strategies, and target-date funds are no exception. But fixed income can also play offense, although generally not to the same degree as equity. For example, high-yield bonds may have equity-like properties while potentially generating a higher level of income.
In the long run, there’s still time to change the road you’re on
In the paper, we discuss how these subcategories fit different stages of an investor’s lifecycle. The early years may be best suited to taking on higher levels of risk, both because this may help build a larger base for the main accumulation years and because younger participants typically have more time to recover from downturns.
As the participant enters prime earning years, it may be appropriate to shift away from some higher beta securities toward those that attempt to mitigate risk while generating income, although it’s still important to maintain substantial exposure to growth through large-capitalization stocks. In the later years, the portfolio frequently keeps a growth component that may offset longevity risk—for example, outliving your money—but it will generally focus on capital preservation through high-quality fixed-income securities.
An allocation to alternative assets, including absolute return strategies that may be relatively uncorrelated to stocks and bonds, can also fit this stage.
New days may dawn for those who stay long
This is simply an outline of the asset classes and investment phases you’ll encounter on our tour of the many glide paths within the main equity/fixed-income glide path. While some of these concepts may sound intricate, the main idea is quite simple: working to help the investor climb the stairway to a long and comfortable retirement.
1 The S&P 500 Index tracks the performance of 500 of the largest publicly traded companies in the United States. It is not possible to invest directly in an index.
Diversification does not guarantee a profit or eliminate the risk of a loss. Rebalancing is the adjustment of a portfolio, either periodically or after significant market moves, to bring its asset allocation in line with the desired levels. Beta measures the sensitivity of the fund to its benchmark. The beta of the market (as represented by the benchmark) is 1.00. Accordingly, a fund with a 1.10 beta is expected to have 10% more volatility than the market.
A target-date fund's performance depends on the advisor's skill in determining asset allocation, the mix of underlying funds, and the performance of those underlying funds. A target-date fund typically has an approximate retirement year of the investors for whom the portfolio's asset allocation strategy has been designed. Target-date funds with dates further off initially allocate more aggressively to stock funds. As a portfolio approaches or passes its target date, the allocation will gradually migrate to more conservative, fixed-income funds. The principal value of each portfolio is not guaranteed and you could lose money at any time, including at, or after, the target date.
Fixed-income investments are subject to interest-rate and credit risk; their value will normally decline as interest rates rise or if an issuer is unable or unwilling to make principal or interest payments. Investments in higher-yielding, lower-rated securities include a higher risk of default.