The Importance of the Glide Path in a Target-Date Investment

The Importance of the Glide Path in a Target-Date Investment

Part 2 Selecting a Target-Date Investment

In part one of this series, we discussed how a target-date investment works and why it’s important to understand the approach an investment manager uses to manage the portfolios. That understanding starts with the journey the portfolio takes as it approaches its target date, as well as how it continues afterwards. This is called its glide path.

Understanding the Path

Understanding the glide path can help you decide which approach might be best if you’re concerned about how long your money could last, especially if your goal is to live off of your savings throughout retirement.

Generally, there are two glide path courses managers take. Keeping in mind that target-date funds contain a mixture of stocks, bonds and money markets, a “to” glide path reaches its lowest exposure to stocks at the target date. That means the ratio of stocks to bonds and money market reaches its lowest point. Then it keeps the same percentage of stocks afterwards. A “through” glide path continues to reduce the ratio of stocks after the target date.

When Stock Exposure is Reduced Determines a To or Through Glide Path

When stock exposure is reduced determines a to or through glide path
Hypothetical glide path examples; does not represent any specific fund family.

Which is Better?

Our investment professionals advocate a “to” approach because we believe the amount of stocks your portfolio is exposed to at and during retirement may be an important factor in determining how long your money could last. Keep in mind that a bad string of market returns as the target date approaches, when stock exposure is decreasing, can result in losses you don’t have time to recover from. At the same time, you want to keep your savings/portfolio growing ahead of inflation to last as long as you need it. Ideally, you would have the optimal level of stock exposure in your portfolio at the target date to last you through retirement.

Evaluating How Long Your Money Could Last

There are two important notes when evaluating a glide path. First, glide path illustrations normally show only stock holdings However, other asset classes can also experience high volatility and risks when markets drop. Also know that target-date glide paths typically treat all stocks the same, even though they are clearly not all created equal. There can be significant differences in volatility, risk and performance. These aspects, for a stock fund that invests in large U.S. companies, can be very different from a stock fund that invests in international or emerging market companies.

The glide path’s shape can tell you a lot about the portfolio manager’s approach to risk.

Steeper Glide Path Slopes May Create a Potentially Wilder Ride

Steeper Glide Path Slopes May Create a Potentially Wilder Ride
Variability is determined by using standard deviation calculations. Standard deviation measures how widely performance has varied from average. It is calculated by comparing monthly returns over a period of time to the fund’s average historical performance, and is an indicator for potential volatility. A very high standard deviation indicates that the range of performance has been very wide, identifying greater potential volatility.
Source: American Century Investments

Steep or Flat: Slope Matters Too

The shape of a glide path—known as its slope—can have a meaningful effect on how susceptible investments are to market risk. Slope refers to how quickly or slowly the percentage of stocks in the portfolio changes.

A steeper slope indicates larger differences in the amount of stock a portfolio has at its beginning compared to its target date. The steeper the slope, the more susceptible your savings could be to market volatility (i.e., the riskier it is). A more measured, or gradual, approach to decreasing stock exposure, a flatter slope, may help reduce overall volatility and loss.

Convenient and Smart

Investing in a target-date fund may be a convenient way to go, especially for retirement. But that doesn’t mean you shouldn’t take an active role in choosing one. Target-date investments give you a painless way to select a well-balanced investment in a single, professionally-managed portfolio. Doing a little homework can not only make your selection process simpler, but also smarter.

Learn more about how target-date funds work and if one might be right for you.

The target date of a target-date fund is the approximate year when investors plan to retire or start withdrawing their money. The principal value of the investment is not guaranteed at any time, including at the target date.

Each target-date fund seeks the highest total return consistent with its asset mix. Over time, the asset mix and weightings are adjusted to be more conservative. In general, as the target year approaches, the portfolio’s allocation becomes more conservative by decreasing the allocation to stocks and increasing the allocation to bonds and money market instruments.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

The opinions expressed are those of Pamela Murphy and are no guarantee of the future performance of any American Century Investments fund.

This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.