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Guide to Glide Paths for 401k

By Paulina Likos · February 15, 2022 · 5 minute read

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Guide to Glide Paths for 401k

Asset managers use a “glidepath” to determine who the asset allocation of a target-date retirement fund will change based on the number of years until the fund’s target date. Each target-date fund has its own glide path, though they typically begin with a more aggressive allocation that gets more conservative over time.

The idea behind most target date fund glide paths is that investors with a longer-term time horizon should have a higher percentage of their portfolio in riskier assets, like stocks, since they have time to recover from short-term volatility. As their retirement date approaches (or once they’ve started retirement), they likely will benefit from a more conservative portfolio that protects the assets they’ve already accumulated.

What Is a Glide Path?

The glide path is the formula that asset managers choose when they put together a target-date mutual fund that determines how and when that portfolio will adjust its asset allocation over time.

Target-date funds (and their glide paths) are common investment choices in 401(k) accounts, as well as in other types or retirement accounts, such as a Roth or traditional IRA purchased through a brokerage account.

Recommended: What’s the Difference Between a 401(k) and an IRA?

A key component to saving for retirement is having a suitable mix of investments that allow for portfolio diversification. Early on, most glide paths focus on stocks that offer the greatest potential to grow in value over time and shifts to bonds and other fixed-income investments according to the investors risk tolerance to manage volatile price swings as retirees or those who are approaching retirement grow older.

Understanding Glide Path

The glide paths within target-date funds create a set-it-and-forget-it investing option for retirement savers, who can get diversification based on their time horizon within a single fund. Investors who are younger and have 20 to 30 years until retirement typically need to maximize their portfolio growth, which requires a much higher allocation toward stocks.

By comparison, someone who has already retired may need to scale back on their portfolio risk. Glide path investing automatically reallocates the latter investor’s portfolio toward bonds which are typically lower risk investments with lower returns compared to stocks but provide portfolio stability. That also means that younger investors in a target-date fund will typically have higher 401(k) returns than older investors.

Types of Glide Paths for Retirement Investing

There are different glide path strategies depending on an investor’s risk tolerance and when they plan to retire. Typically, target-date funds have a declining glide path, although the rate at which it declines (and the investments within its allocation vary depending on the fund).

Declining Glide Path

A declining glide path reduces the amount of risk that a target-date fund takes over time. In general, it makes sense for retirees or those approaching retirement to reduce their investment risk with a more conservative portfolio as they age. A decreasing glide path is the more common approach used which involves a higher equity risk allocation which steadily declines as retirement approaches.

Static Glide Path

Some target-date funds may have a static glide path during some years. During this time, the investment mix would remain at a set allocation, such as 60% stocks and 40% bonds. Managers maintaining portfolios that have a static glide path rebalance them regularly to maintain this allocation.

Rising Glide Path

Some researchers believe that the glide path should begin to rise again once an investor reaches retirement age, taking on more risk over time.This argument holds that by increasing risk in a retiree’s portfolio could reduce volatility in the early stages of retirement when the portfolio is at risk of losing the most wealth in the event of a stock market decline.

An increasing glide path may work for retirees with pension benefits or higher withdrawal rates or who is working in retirement. If a retiree is comfortable taking on more risk, this strategy may make sense, however, generally speaking, the rising glide path is the least utilized method for retirement planning.

Choosing the Right Glide Path

If you’re saving for retirement in a 401(k), there may only be one target-date option available to you based on your target-retirement age. However, if you have choices within your 401(k) or you’re choosing a target-date fund within an individual retirement account or another investment vehicle, you’ll want to look for a target-date fund with a strategy that aligns with your investment view.

One rule of thumb uses “rule of 100,” which subtracts the investor’s age from 100 to determine the percentage of your portfolio that should be in stocks. However, some managers use glide paths that decline more or less quickly than that.

Some target-date funds also incorporate alternative assets, such as private equity or real estate, in addition to traditional stocks and bonds.

”To” or “Through” Retirement

When glide paths reach retirement date, they can take one of two approaches, either a “To” or “Through” approach. A “To” retirement glide path is a target-date fund strategy that reaches its most conservative asset allocation when retirement starts. This strategy holds lower exposure to risk assets during the working phase and at the target retirement date. This means, at retirement, it reduces exposure to riskier assets, like equalities, and moves into more conservative assets, like bonds.

“Through” glide paths tend to maintain a higher allocation toward riskier assets as investors accumulate savings, at their target retirement date and years into retirement. This means exposure to equities in retirement tends to be higher, at least in the first few years of retirement.

In making which path is best suited for each investor, you must determine your risk preference and how aggressive or conservative you are able to be. This includes deciding how much exposure to equities you can afford to have. Decreasing exposure to stocks means investors don’t have to worry about a portfolio that fluctuates in value, whereas, an increased exposure to equities may mean a portfolio with more volatility but over time, it has potential for greater gains.

The Takeaway

Glide paths are formulas that investment managers create to determine the level of risk in a target-date fund. This allows investors in those funds to take a hands-off approach with a portfolio that automatically adjusts itself based on risk tolerance that changes as investors age.

SoFi does not currently offer target-date funds, but it does provide an opportunity to open an IRA account through the SoFi Invest® online brokerage. SoFi Automated investing offers automated, algorithm-driven financial planning that creates and rebalances a portfolio on your behalf.

FAQ

What does glide path approach mean?

A glide path refers to a formula that asset managers use to determine the allocation mix of assets in a target-date retirement portfolio and how it changes over time. A target-date retirement portfolio tends to become more conservative as the investor ages, but there are multiple glide paths to take account to a retiree’s risk tolerance.

What is a retirement glide path?

A retirement glide path is the approach within a target-date fund that includes a diversified portfolio of stocks and bonds. Retirement glide paths typically start out with a more aggressive mix of investments and get more conservative over time.

Which type of mutual fund follows a glide path?

Target-date retirement funds are the most common type of mutual fund that follows a glide path. However managers may also use glide paths for other time-focused, long-term investments, such as 529 retirement accounts.


Photo credit: iStock/akinbostanci
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