Friday, March 6, 2015

Glide Paths

Retirement researchers Michael Kitces and Wade Pfau published papers on glide paths in the Journal of Financial Planning in 2014 and 2015, including Retirement Risk, Rising Equity Glide Paths, and Valuation-Based Asset Allocation, suggesting a rising glide path for retirees beginning with a low equity allocation early in retirement and rising throughout. Researcher David Blanchett has published contradicting studies that show better performance from declining equity glide paths throughout retirement, which has been the traditional recommendation, in Revisiting the Optimal Distribution Glide Path.

As you can imagine, these conflicting recommendations have caused more than a little anxiety among advisers and do-it-yourselfers and experts like William Bernstein have even entered the discussion.

Ultimately, the research has left some retirees asking whether they should follow a rising glide path or a declining glide path.

The correct answer is "none of the above" – they should follow their personal financial situation as retirement progresses. (See Dominated Strategies and Dynamic Spending.)

Imagine two 90-year old retirees. Rising glide paths would suggest that they both hold large equity positions, while declining glide paths would suggest they both hold large bond positions. Now imagine that one still has tons of savings left, more floor income than she needs and is, as William Bernstein puts it, investing for her heirs. The other has barely enough wealth left to cover another five years of expenses. Should both invest with the same asset allocation because they are the same age? A similar argument can be made at any age and the correct answer is that we need to consider more than age or retirement date when determining our asset allocation.

This research aims to isolate one factor, the retiree's planned retirement date (or, roughly speaking, the retiree's age), and to determine its effect on the retirement investment problem. The question it attempts to answer could be framed in a number of ways, like:

  • What would be the best asset allocation pattern for a retiree if we only knew that retiree's planned retirement date and nothing more?

  • What allocation should we recommend to a retiree who wants to do little or no investment planning? (Note that this person is unlikely to be a reader of this blog.)

  • What glide path should be implemented by a target-date mutual fund that serves a broad target market of retirees who happen to share the same planned retirement date?

I feel certain that all of the authors of these papers would agree that a customized, individual retirement plan will always be preferable to one based entirely on the retirees age/retirement date. (One of the authors actually told me this, so it isn't entirely a guess.)

As explained in Wade's post of March 2nd on, To Rise or Not to Rise, the authors are currently comparing notes to understand why their results differ. Initial thoughts are that the differences are explained by different capital market expectations. Both sets of expectations, or assumptions about future markets, are imperfect predictions and either (or neither) might turn out to be right.

As Wade explains, "… The choice of glide path is not always fixed, as it does vary with the stock market valuation level at the time of retirement."

So, which glide path is best if we ignore everything about a retiree except the planned retirement date? We're not sure, but the research does seem to show that it depends on stock market valuations and interest rate expectations at the time of retirement (no surprise).

How does this information help the typical retiree invest her savings if she doesn't really care how the mechanisms of retirement funding work? It doesn't help much, in my opinion, at least not at this point. As Blanchett suggests, more research is needed.

More importantly, this information won't apply to most advisers or do-it-yourselfers because they will be willing to do more work than to simply write down a planned retirement date. They can find a much better fit.

An individual household's optimum asset allocation should be estimated by considering several more factors, including how well their retirement is funded and the maximum loss they could stomach in a bad market crash. By continually managing asset allocation based on current conditions of the retiree's finances, at the end of retirement that retiree's glide path will have followed some curve that will probably look like one of the half dozen or so currently recommended glide paths simply because they pretty much cover the entire range of possibilities. (The 2014 Investor's Guide issue of Money magazine identified six glide path recommendations that had little in common. Pozen's has a tongue sticking out the end. What's up with that???)

We will not know in advance which glide path that retiree will end up following. It will be determined by a random walk through market returns, how long we live, our expenses, the decisions we make and many unpredictable factors.

It's important to understand that research of any kind is new information, or a new argument, that we should consider in light of what we already believed to be true. It doesn't automatically replace what we thought we knew. (See Think Like a Bayesian Pig.)

When this evidence conflicts, it gives us a chance to learn more. This research doesn't tell us that one glide path is better or worse — both sides make good arguments — but it begins to tell us under what conditions one glide path might perform better. That doesn't necessarily mean one is right and the other wrong or even that a well-planned retirement needs one. Please keep that in mind when you read academic papers. They are usually new evidence or new arguments and not universal truths that dispel old beliefs.

What should a retiree do with this information about glide paths? Probably nothing. You should customize your asset allocation instead of following a glide path. There are a couple of interesting points you can use, however. First, it turns out that a 60% equity portfolio throughout retirement isn't a bad "couch potato" allocation.

Second, as Wade points out, you might give more consideration to cash and short bonds than to intermediate bonds. "Another important point in that summary is that we did look at both short-term (6 month or 1 year) bonds as well as 10-year bonds in our analysis, and we found that the shorter-term bonds were of much greater help than longer-term bonds. When the focus is on protecting from downside risks, the additional volatility caused by the 10-year bonds hurt retirement outcomes by more than could be compensated by their higher average yields. This ties into David’s article as well, since his bond allocation was 75% to (I believe) 10-year bonds, and 25% to cash."

This is an important point to remember when you think about taking on more risk to increase the return of the bond portion your retirement portfolio. Bonds and cash are there to protect against downside risk, not to maximize portfolio return.

You can also just follow the ongoing research. I find the discussion quite enjoyable. It's a work in progress.


  1. Dirk, thanks for another thoughtful blog post emphasizing that a personalized glide path is best. For my two cents I take into account such things as risk aversion, funded ratio, length of time money must last, withdrawal rate, asset allocation, market valuation (CAPE 10), etc. when deciding upon my asset allocation. I try not to be conservative when assessing my risk aversion as well. As you suggested previously I will also try to revisit my allocation every year using the Moshe Milevsky portfolio ruin calculation spreadsheet. Finally, I try to let the statement "to take no more risk than you have the ability, willingness or need to take (or are compensated for taking)" guide my asset allocation decisions.

    I would be curious whether you think based on what Wade says about bond funds above (short vs intermediate) that a shorter term bond fund would be better than a Total Bond Market fund (an intermediate bond fund) in one's retirement asset allocation. I have seen where there is conflicting opinions on this with some like Bernstein and Wade above advocating for short term bond funds while others say the sweet spot is an intermediate fund like the VG Total Bond Market Fund. Swedroe on the other hand looks at the yield curve and determines whether the extra yield warrants the additional term (each additional year has to provide at least 0.2% more yield for it to be worth the term risk). I know this is not the focus of your blog, but just curious your thoughts. Thanks, Brad.

    1. Brad, I think they're probably all correct. Swedroe and others are saying that intermediate bonds hit the sweet spot for risk-adjusted return. In other words, if your goal were to make the most profit on bonds while being adequately compensated for the associated risk, intermediates are often the way to go.

      Pfau and Bernstein are saying that the best way to protect your retirement portfolio's downside is to use short bonds and cash. The goal in this scenario is to limit losses while the goal in the first scenario is to maximize risk-adjusted return.

      Hope that helps.

    2. If you're in the capital accumulation phase (that is, you're still working, saving for retirement), then just use the Total Bond Market index fund as the volume nob on your portfolio, to dial in the amount of risk. You don't need to bother with short-term bond funds.

      When you start retirement and begin taking distributions, you want to be shifting into short-term bond funds, or TIPS bonds, or CDs, etc, and use these as your income floor (a point often made by Dirk and others). You can do this as during the normal portfolio rebalancing. You still have stocks (e.g. Total Stock Market index) and your Total Bond Market index fund, but now you also have short-term bond funds too.

    3. Good point, Matthew. I am focused on post-retirement planning and often find myself unintentionally overlooking accumulation. Thanks for the comment.

  2. Thanks Dirk. I guess you are right - extra return does not come without extra risk. I guess I was hoping I could have a Cadillac at a Yugo price (one fund to serve both purposes - downside risk and return as well). Swedroe also said that the lower stock allocation you have the more likely your bond allocation should be in short term bonds because you are risk averse, and conversely the higher stock allocation you have your bond portion should be in intermediates since most of the fluctuation in your portfolio will be due to the stock portion. It is so different when you are retired. You can't just say I want the best return because I have years before I retire. You have to think about preserving in addition to growing. I do like that when stocks tank intermediates generally (when they move in the opposite direction) go up more than short term bonds to soften the blow, but when both stocks and bonds go down intermediates exaggerate the downside movement of my portfolio. Up until now I have just been putting about 1/2 of my fixed income in short term bonds and cash (paying 1-4%), and the other half in intermediate bonds (total bond market). I usually try to split the difference when I have a choice I can't decide on figuring I'll only be half wrong. Thanks Dirk for your advice as always. Brad

    1. Growth comes from stocks in your retirement portfolio. The purpose of bonds and cash is to protect the downside, not to increase growth.

  3. Dirk, agreed. I guess in my mind there is a time dimension to the decision between shorter term vs intermediate term bonds (which to use). I could foresee where the absolute best short term downside protection one might have would be cash, but over the longer term intermediate bonds would beat cash. Is the decision rule as simple as 'match my bond selection (short or intermediate) to the length of my need.' In other words match my bond duration to the time frame over which I will need the bond money. Shorter term needs shorter term bonds etc. As long as the duration of my bonds is shorter than when I will need the money then I should be alright. This would seem to give me the best of both worlds ie. protection where I need it most with short term need money in short term bonds and longer term need money in intermediate term bonds where the return over time is higher than cash. Here is a link to a discussion on Bogleheads forum. I like Taylor Larimore's comment, and Larry Swedroe's. If I plot historical volatility of the VG short term bond fund vs VG total bond market fund in Morningstar the curves move pretty much in tandem. Thanks for your insight. Brad

    1. Brad, I think you are combining several aspects of bonds that are actually distinct.

      If you have a known future liability, then you can match the duration of the liability with the duration of the bond and know fairly precisely how much your bond will be worth on that date. You want the duration to match, not to be shorter. If it's shorter, you won't know your reinvestment rate from the beginning. The liability may be of short, intermediate or long duration and requires a bond of similar duration.

      Risk-adjusted return is different. By investing in intermediates, which often offer the best risk-adjusted return, you are most likely to receive the greatest return on your bond after considering risk. In other words, you might be able to get a little more return with longer bonds, but only by taking a lot more risk. You would use this characteristic if you wanted to optimize your bond return.

      Downside portfolio protection is different from either of these. Instead of trying to ensure that you have the right amount on money to meet a future liability when it is due, or to earn the highest risk-adjusted return on your bond investments, you are trying to protect your retirement portfolio from both normal market volatility and market crashes. This is what Wade found often to be best accomplished by short bonds and cash.

      You won't be able to achieve all three goals with one bond duration, so you're going to have to choose a goal.

  4. Thanks Dirk. My foremost goal in retirement I guess is to limit downside protection so I would go with cash and short bonds based on above, but why then do the Target retirement funds for VG use the Total Bond Market (TBM) fund as their bond holding? The TBM fund I assume has short, intermediate and long term bonds that on average have an intermediate duration which would seem to on average have the goal of maximizing risk adjusted return. What should be a conservative retirees bond goal be (I think Swedroe and Bernstein would say short term bonds and cash to limit downside protection)? Thanks, Brad.

    1. The goal of target-date funds is to maximize return for a given level of volatility. Intermediate bonds would do that. They're not trying to match liabilities or provide a floor. They're basically growth and income funds.

      What that conservative retiree's bond goal should be depends on what he or she is trying to accomplish. Build a floor? Protect against a crash? Dampen volatility? Match liabilities? Maximize total return?

      I'm not a fan of target-date funds. I think you should control your own asset allocation, so I wouldn't recommend trying to mimic them.

    2. But the VG TR funds do shift into short-term bond funds as get near to the retirement date.

      Remember that a distribution portfolio still has a growth component, since you need some growth to compensate for inflation. (You want a 0% real return as the lower bound, so you need to take some risk, just not as much as when you were in the accumulation phase.) So the need for the Total Bond Market index fund doesn't go away during retirement. It's just that in a distribution portfolio, you also have short-term bond funds (or other, cash-like instruments), in order to defend against downside risk.

    3. Thanks, Matthew. Great points.

      As I stated, I prefer to decide on my own bond allocation and structure rather than let a target-date fund manager who has to serve the needs of many do it for me based solely on my age and a glide path. (Particularly when there is much conflicting research on what that glide path should be.)

      Thanks for contributing to the discussion!

  5. Amen Dirk ... "You should customize your asset allocation instead of following a glide path."

    The reason a rising glide path occurs is through SWR assumptions where a portion of the portfolio is not used for spending because of the conservative spending derived from the approach. If it is not used for spending, then it can grow. The more it grows, the less is used for consumption and thus can be allocated more aggressively = a rising glide path.

    The declining glide path is a result of allocating more of the portfolio towards spending. The difference between the two approaches is essentially what you've called flexible spending - I label it discretionary (a term you don't prefer I know) - point is some spending that may or may not be possible depending on market behavior. That sounds scary, but David Blanchett's work suggests flexible spending results in better overall results.

    Monte Carlo simulations will drive a less volatile allocation solution if more of the portfolio is subject to spending (a higher percentage of simulations fail to make it to the end of the simulated period). This is how one customizes their results by using factors they're comfortable with.

    Our own research data suggests starting with a 40% equity exposure at retirement provides an optimal withdrawal and equity slowly declines as one ages. The less time one has remaining, the less equity suggested by simulations.

    So the mystery of why both results coexist in research is simply how constrained (SWR approach) or how unconstrained (dynamic approach) a portfolio balance is subjected to for spending considerations at any given age.

    1. Thanks, Larry. I hope to return to our discussion soon as workload allows. (Who knew retirees would have workload?) Appreciate you furthering the explanation here.

      A couple of points. I have no problem with the term "discretionary expense", but I do have a lot of trouble identifying what I personally consider discretionary, so I suspect others do, as well. I also have trouble imagining living on discretionary expenses alone, so I consider that line below the minimum lifestyle I would want to support. While we would probably all agree that Showtime is a discretionary expense, is a cell phone? Bottom line, I don't find this a very useful line to draw for retirement planning, though it might work for others.

      The conflicting research doesn't surprise me, at all. The ultimate answer is going to be "it depends" and we're beginning to see what it depends upon. Shouldn't impact a retiree's dynamically updated planning either way.

      By the way, Showtime is clearly discretionary. For the record, HBO is not.

      Thanks, as usual, for your contribution to the discussion.

  6. I find it interesting that pretty much all of the glide paths are shown to be smooth in the transition from the accumulation to spending phase. This is similar to the nice pretty graphs showing parabolic asset accumulation through ones life using an average return assumption. However, in reality those pretty accumulation and decumulation graphs look something more like the route profile of the Tour de France.

    The more I have looked at the upcoming transition to retirement in our 60s, the more I have realized that our portfolio is going to look quite bumpy for much of that time instead of a nice glide path. There are numerous dates in there for decisions such as when to take a pension, when and how to take Social Security, when to quit work (one or both) etc. Each one of those is a step function in how much income comes in or ceases with corresponding decisions on how the savings portfolio will be managed to address those.

    So I have been assuming that in our 60s, we will likely have a "traditional" portfolio glide path at the beginning, but then the ride gets bumpy as assets get converted into cash (or similar) cushions, TIPs bond ladders, possibly annuities, and the remainder restructured in a long term investment portfolio. Some of the portfolio will be used to temporarily cover shortfalls in guaranteed income, such as deferring one person's Social Security to age 70, or to provide additional discretionary funds for travel etc. per the "U"-shaped spending curve.

    It is likely then that much of the short-term types of funds will have been spent on to cover one time expenses such as replacing deferred income and for discretionary expenses by age 71. At that point, the longer-term portfolio will have a more defined look to it with another smooth glide path as the guaranteed income from outside sources should now largely be flowing in.

    So my working assumption now is to have a fairly conservative glide path in our early 60s to reduce volatility and the risk of permanent capital loss right when things are being converted into cash for spending to cover the cessation of work incomes while deferring guaranteed income streams. Once that restructuring has occurred, then the portions of the portfolio that are not used to create a safety net of guaranteed income streams (including TIPs ladders) could be reshaped into a relatively aggressive growth structure to address the longevity risk of inflation - a simple way to do this would be to use a new Target Date fund that assumes retirement age when you are actually around 85-90 years old, so that once again portfolio volatility would be reduced later in life after a couple of decades of growth.

    1. Rather than try to find a target-date fund that happens to coincide with the asset allocation you think you need, why not just create your own portfolio allocation? Then you'll have complete control. Why leave the decision to a fund manager?

      The glide path research is just that -- research. That's why the glide paths are "pretty". To quote Wade Pfau, a customized plan is always preferable for an individual.

      Lastly, when income and expenses are not consistent throughout retirement, consumption-smoothing software like E$Planner might be a useful tool.

      Thanks for your comments!

  7. Hi Dirk,
    Been trying to follow all this research as well so that I can apply to my individual situation. Currently I am 56 and am planning on retiring in 5 years and am starting to think about adjusting my portfolio AA in preparation for retirement and as a means to reduce the sequence of returns risk that can happen just prior to and/or early into retirement. I am currently adjusting my AA each year on a declining glide path up until I'm 80.

    Was hoping i could find something more definitive on the glidepaths but I guess it is still in the discovery phase. You mention a customized plan is always preferable. I already use a financial planning software similar to ESPlanner and have a complete plan based on my above mentioned personal glidepath.

    Can you elaborate more on what you mean by a customized plan with respect to AA and glidepath?


    1. Sure. Good question.

      If I knew more about your financial situation, I think I could suggest a reasonable equity allocation for your final ten years or so before retirement. It would probably be between 40% and 60% equities, because I wouldn't want you to end up like many people who were about to retire in 2006 and had plenty of savings. When the market tanked 50% in 2007-2009, they suddenly found themselves looking at several more years on the job – if they were lucky enough to retain their employment.

      What should your equity allocation be when you are 80? No one knows. If the market treats you kindly and you stay healthy, you might have a large portfolio by then. Or, you could have huge medical expenses and/or poor market returns and have very little savings remaining. The appropriate equity allocation when you are 80 might be 100% or it might be 10% or you might have no savings to invest. Only time will tell.

      If I don't know what your allocation should be in 25 years, how can I know what glide path will take you there?

      There is no rational reason to choose future asset allocations today and stick with them no matter what, hence, no reason to select a glide path in advance. Fix it when you get there.

      Wade Pfau explained glide paths quite well when I discussed this with him. A glide path is something we would choose if we knew nothing about you except your age. It is also something that makes sense for a target date mutual fund that hopes to attract investors with a wide range of financial situations. It is also an informative research tool.

      But you know a lot more about your financial situation than just your age, so choosing a customized asset allocation annually, based on whatever conditions exist for you at that time, will always be preferable.

    2. Thanks Dirk for the feedback. Right now my equity portion is 59% so I feel ok with that. I was planning on slowing reducing that % as time goes by as is the standard thinking from what I can tell assuming nothing major comes along. I do perform Monte Carlo simulations that show me above 90% success rate with my assumptions. So the plan is fine as of now.

      My concern right now is whether to drop that % equity much lower over the next 5 years as a means to reduce and sequence of returns risk that might delay my retirement. Then, what to do in the first 10 or so year after retirement again to reduce sequence of returns risk.

      My thought pattern has always been that as long as I don't need the funds in the next 5 years that equity exposure for those funds is good as it gives time for the markets to recover and thus I'm not selling when the asset is down.

      Reducing equity exposure for the next 15 years (5 before and 10 after retirement)would help with reducing sequence of returns risk but could severely hinder the long term success of the plan. Not reducing is could do the same if the market hits a major correction. So, what to do. That's my dilemma.

      How are you assuming one determine the customized asset allocation annually? I do rerun my financial plan each year and I could use that to determine if I need to change my allocations. My concern with this is that if I'm not careful over the next 15 years I may end up with having to take a lot of risk in my 70's and 80's and I may end up not having enough funds.

    3. "My concern right now is whether to drop that % equity much lower over the next 5 years as a means to reduce and sequence of returns risk that might delay my retirement. Then, what to do in the first 10 or so year after retirement again to reduce sequence of returns risk.”

      The research, including Wade Pfau’s work on rising glide paths, says to reduce your allocation early in the first decade after retirement and the last decade before. I like 40% to 50% equities in those time periods, but it depends on your risk tolerance. I also don’t believe it is possible to calculate a precise optimal allocation. A fairly broad range of equity allocations will work.

      "My thought pattern has always been that as long as I don't need the funds in the next 5 years that equity exposure for those funds is good as it gives time for the markets to recover and thus I'm not selling when the asset is down.”

      I agree during accumulation, but after retirement you will probably be selling constantly. The bucket approach of holding cash so you don’t need to sell stocks in a downturn doesn’t seem to work. When you're selling, that recovery takes a lot longer.

      "Reducing equity exposure for the next 15 years (5 before and 10 after retirement)would help with reducing sequence of returns risk but could severely hinder the long term success of the plan. Not reducing is could do the same if the market hits a major correction. So, what to do. That's my dilemma.”

      Yes, that’s every retiree’s dilemma.

      "How are you assuming one determine the customized asset allocation annually? I do rerun my financial plan each year and I could use that to determine if I need to change my allocations.”

      That’s the way to do it.

      "My concern with this is that if I'm not careful over the next 15 years I may end up with having to take a lot of risk in my 70's and 80's and I may end up not having enough funds."

      This is my biggest concern with your plan. I wouldn’t be comfortable with any retirement plan that would leave me short of income if the market performed poorly. That’s the reasoning behind floor-and-upside strategies. Secure an amount of income that you would provide your minimally acceptable standard of living and invest what’s left for upside. Then your standard of living isn’t held captive by stock market returns.

      Good luck, Ed. Enjoyed the discussion! Thanks for writing.