Two recent studies challenge the most fundamental assumption undergirding the construction of virtually all target-date glide paths: that the best strategy is to wind down equity exposure as a DC investor nears retirement.
We reviewed the first one, “The Glide Path Illusion and Potential Solutions,” in this NAPA Net post. The study demonstrates the superior performance of maintaining, throughout the accumulation period, a 50/50 allocation to equities and bonds compared with a 80/20 wind-down to bonds strategy.
The second study, “Reducing Retirement Risk with a Rising Equity Glide Path,” demonstrates that, “a steady or rising glidepath provides superior results compared to starting at 60% equities and declining to 30% over time.”
It’s interesting to note that as recently as last year we witnessed the emergence of terms such as “the glide path illusion” and “rising equity glide paths.” In many respects this shows just how much we still have to learn regarding the best way to construct target-date glide paths. Most importantly, the question to be resolved is whether or not the way that all major money managers and investment advisors currently construct their current glide paths (i.e., the winding down of equity exposure) is, in fact, way off base.
The challenge with these studies is that the results are viewed in the aggregate rather than from the perspective of how specific individual investors could be affected. Two simple facts virtually guarantee that, in the cumulative, a rising equity glide path will outperform a rising bond glide path:
• over just about any 20-year period, equities outperform bonds; and
• investors have their largest account balances as they near retirement.
However, what the two studies fail to capture is the impact on individuals nearing retirement laden with equities just before an extended bear market. Viewing the historical performance of the S&P, there is a wide divergence of returns over any 20-year period. The worst 20-year (real) return period was -2% between 1948-1968, while the best was 8.4% between 1961-1981, as reported in a New York Times article, “In Investing, It’s When You Start — And When You Finish.” In reality, that really captures the whole point: Many individual investors could have their retirement savings greatly depleted while others could do quite well, depending on when they enter the market and when they exit.
In summary, this discussion regarding equity wind-down or wind-up glide paths is just beginning. The jury is still out on what constitutes the best way to construct a glide path. In fact, not only is the jury still out, but they are just now beginning to consider the evidence for both cases. Ultimately, a model may emerge in which equity weighting is less a function of where an individual is on their accumulation trajectory and more about market valuations at different entry and exit points.
What we do know is that plan advisors need to stay tuned to this evolving discussion as additional research and the theoretical framework around glide path investing continues to mature.
