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Glide paths (retirement)

Updated: Apr 17, 2022

If you are preparing for retirement and haven't heard of glide paths, you should take a pause here and read this article.

Glide paths represent the asset allocation mix of a fund based on the number of years it has to the target date (usually represented as retirement). You see, when you are preparing for retirement, your asset allocation mix should change over time as your capacity to take on risk changes during pre-retirement, on retirement and post retirement.

Here is an example of how a glide path looks like.


There is usually a consensus between many well-known names and research firms in the glide path prior to and at retirement date. Equity allocation generally drops as one approaches the retirement date with the lowest point logged at the retirement date. The part where there are different opinions lies in the phase after the retirement date. Some believe that the equity allocation should continue to drop. Some believe that the equity allocation should remain the same. And lastly, some believes that the equity allocation should in fact increase.

In traditional retirement planning where people work till 65 years old with only probably 30 years to go before they meet their maker, the belief that the equity allocation should continue to drop as withdrawals are being made seems to sit well with many people. However, if you think about it deeper, the sequence of returns risk might just screw up your plans.

In this paper by JP Morgan, you can see that annual returns in retirement actually matter much less than the sequence of those returns. If the initial years of your retirement are hit with a global financial crisis and generate dismal annual returns, your portfolio will end up much worse than a portfolio which has a great start even if the average annual returns are the same in both scenarios. In some cases, the portfolio with initial bad years might not even see you through your retirement years as it goes to zero before you make your maker (which is probably the scenario that nobody wants). So if you were to be dropping your equity allocation from retirement age onwards, your equity allocation is going to be the highest in the initial years of your retirement and hence you are exposing yourself to a lot of these sequence of returns risks.

This is where maintaining a static equity allocation line or even increasing it in your retirement years makes more sense. As we move along in our retirement years, it's true that our willingness to take on risk becomes lower. But what's also happening on the other end is that our capacity to take on risk actually becomes higher (simply from the fact that we will have fewer years ahead of us and hence the risks have less of an impact). When we balance these together, it usually makes sense to maintain a static equity allocation or even increase it.

In recent years, more and more of us are looking at adopting FIRE (Financial Independence, Retire Early). This brings us to a situation where we are targeting to have more years in retirement. If you FIRE at the age of 40, you are going to have 25 more years in retirement as compared to someone who retires at 65. With this increase in retirement years, it becomes apparent that you can't afford to drop your equity allocation as it's simply unsustainable to drop your equity allocation and still have enough for your constant withdrawals. Unless of course, if you have a huge retirement sum to begin with and your withdrawal rate is less than 2%.

So as we all prepare for our retirement or even aim for FIRE, do remember that the journey does not stop when you retire. In fact, the path after your retirement starts matters too and you shouldn't be looking at liquidating all your equities once you retire.

When I run a poll on the Seedly community group recently about which retirement risk are people most afraid of (shown below), the top answer is longevity risk. That is certainly some food for thought here. The journey to grow your retirement sum should continue even when you are doing your withdrawals, albeit with less risk.

If you are looking for a good article about guide paths in retirement, you may like to check this out.

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