Re-thinking the equity glide path

July 2, 2014

July 2 (Reuters) – The equity weighting glide path – the
idea that savers should cut risky holdings of stocks
mechanically as they approach retirement – is an appealing
metaphor, easy to understand and instinctively right feeling.

But for many, especially those unlucky enough to live
through one of the many historical extended periods of low
returns, that glide path ends well short of the runway.

One of the fundamental early insights of investing has been
that, as equities are volatile, as you approach needing your
savings to live on you should cut back on stocks and buy bonds.

That underlies the old wealth advisor’s rule of thumb: that
one should have an equity weighting of 110 minus current age,
giving a 55-year old, for example, a 55 percent exposure to
stocks but a 25-year-old an 85 percent weighting.

Most target-date funds, which have become hugely popular
among savers in defined contribution plans, also follow similar
paths, ratcheting down equity exposure on a glide path to

That works well if returns are typical, but they too seldom

Ben Inker and Martin Tarlie of asset manager GMO, who looked
at this approach and ran the numbers on how it would perform
using data going back to 1881, found some disturbing outcomes.

Using a typical target-date fund allocation formula as a
hypothetical, and assuming a 55-year-old saver who at that
juncture was on target for generating the wealth needed for
retirement, Inker and Tarlie found the poor soul running out of
money before age 95 more than half the time. (here)

While that is counterbalanced by the near equal number who
still have money, some a very tidy pile, it is a shockingly bad
result in a time in which an increasing number of people are
living to an extended age.

“We believe that the right way to build portfolios for
retirement is to focus on how much wealth is needed and when it
is needed, with a focus not on maximizing expected wealth, but
on minimizing the expected shortfall of wealth from what is
needed in retirement,” Inker and Tarlie write.


The real problem with target-date funds, indeed with much
investment thinking, is that it assumes that expected returns
will be constant over time, something that really can only be
taken for granted by those of us who will live forever.

For the rest of us, we have to deal not just with volatility
on a day-to-day and quarter-to-quarter basis, but with the very
real risk that we just happen to be saving at a bad time. Just
looking at U.S. data also probably gives an unrealistically rosy
picture of how often this happens. Just think, to name but one
example, of all the Germans whose retirement equity savings
would have been wiped out by World War I.

One useful tool in managing risk, of variation in returns if
not of war, is using valuations as an input to help determine
how much to commit to stocks. There has been a strong historical
correlation, Inker and Tarlie point out, between stock market
valuations and subsequent returns.

In other words, if you hold less equities at times of high
valuation and more when stocks are cheap you can improve your
returns even while still broadly following a glide path towards

For example, if the market was on a Shiller P/E of 19 (vs a
typical 16), a 65-year-old might hold just 20 percent in stocks,
about half the typical target date fund allocation.

Running the numbers on this dynamic allocation approach,
Inker and Tarlie find that the probability of our 55-year-old of
going bust before 95 drops to 13 percent, as against 52 percent
for the target date example. Not perfect, but a heck of a lot

To be sure, returns revert to mean but often not on
schedule. That said, the longer you can wait the higher the
chances are that your over- and under-weighting based on
valuation pays off.

One other tool which seldom gets discussed in managing these
risks is the simplest: the savings rate. Savers who are running
behind their wealth accumulation targets for whatever reason
really should be upping their contributions.

While not an easy sell to a client (“Invest with us and
consume less!”) this reduces the risk of a shortfall in
retirement without compelling the saver to make judgments about
the likely future path of markets.

With more than $650 billion invested in target-date funds,
according to Morningstar data, the stakes for a nation
increasingly populated by future 95-year-olds are high.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at and find more columns at

(Editing by James Dalgleish)

One comment

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I like the aviation metaphor.

I’d argue that savings are like altitude to a pilot. Altitude is always your friend since enough altitude keeps you from unanticipated contact with terra firma should you run into trouble up there.

Debt is like weight. A heavy airplane will climb sluggishly (like saving little) and fly poorly. An overloaded craft is much more likely to crash than a properly loaded one. Similarly families who are heavily in debt are much more likely to run into financial difficulty.

Again using the mataphor, it seems to me that a lot of people are set to crash on take off due to an overload of debt when health or economic issues force them into retirement. If your plane is too heavy it just won’t fly.

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