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Don't let the exception guide your glidepath

04 September 2018 | Garrett Harbron

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When it comes to investing for your retirement, the choice of funds is only half the story. Equally important is to ensure you are gliding along the right “glidepath”. In simple terms, a glidepath describes a retirement portfolio’s changing asset allocation. It is the mechanism by which an investment fund automatically moves an investor’s assets into less risky, more secure investments as they get closer to their selected retirement age.

Some glidepaths take a very gradual approach, taking decades to move from their starting allocation to their final allocation. Others take a very aggressive approach, going from starting allocation to ending allocation in ten years or less. At Vanguard, we believe a gradual approach is best.

The downside of a steep glidepath

A steep glidepath quickly reduces an investor’s exposure to equities as they approach retirement. Theoretically, this protects investors from the impact of a significant market decline in the years immediately prior to retirement. This makes some sense as equities are seen as more risky than bonds. However, while equities tend to lead declines, they also tend to lead the subsequent recovery.

Figure 1 shows the market bottom of the FTSE 100 for the five most recent bear markets (defined as a market that has fallen by 20% or more from its peak) and its performance in the following 12 months. Clearly, the year following a bear market tends to see strong returns.

Figure 1: Equity bear market recoveries

Date of market bottomLevel at market bottomLevel 12 months later12-month % change
09/11/1987 1,565 1,840 17.60%
05/10/1998 4,649 6,053 30.20%
10/03/2003 3,436 4,542 32.20%
03/03/2009 3,512 5,484 56.20%
11/02/2016 5,537 7,259 31.10%

Notes: Shows the value of the FTSE 100 at the bottom of each bear market and its level 12 months later. Bear market is defined as a decline of 20% or more from the market’s previous high.

Past performance is not a reliable indicator of future results.

Source: Vanguard calculations using data from Morningstar, Inc.

A steep glidepath may miss out on these market rallies. Because the equity allocation in these glidepaths decreases quickly, they have a greater exposure to the bear market than the subsequent recovery. This can result in a significantly lower pension balance for investors at retirement.

Steep vs. shallow: A comparison

To illustrate, let’s take a look at two glidepaths and the potential impact they could have on an investor. As figure 2 shows, both glidepaths start at a 60% equity/40% bond allocation at age 55. The shallow glidepath reduces its exposure to equities slowly and, at age 65, its allocation is 50% equity/50% bonds. The steep glidepath reduces its equity exposure much more quickly and, at age 65, its allocation is 0% equity/75% bonds/25% cash.

Figure 2: Steep vs shallow glidepaths

 
Steep vs shallow glidepaths
Steep vs shallow glidepaths B

Source: Vanguard

In figure 3, we can see the notable difference between what these two glidepaths would have made for an investor who turned 55 at the peak of the previous market cycle, in October 2007, with £100,000 in his pension pot. Initially, the value of the two portfolios is very similar, but as time goes on and the equity allocation in the steep glidepath becomes smaller, the returns start to diminish, resulting in a difference of more than £23,000.

Figure 3: The steepness of the glidepath matters 

The steepness of the glidepath matters
Notes: Shows the value of £100,000 invested from 1 November 2007 to 30 September 2017 in the respective glidepaths. The shallow glidepath begins at 60% equities/40% bonds, ends at 50% equities/50% bonds, and is rebalanced monthly. The steep glidepath begins at 60% equities/40% bonds, ends at 0% equities/75% bonds/25% cash, and is rebalanced monthly. Equities are represented by the FTSE 100 Total Return index, bonds are represented by the Bloomberg Barclay’s Global Aggregate Total Return Hedged GBP index, cash is assumed to return 0%.

Source: Vanguard calculations using data from Morningstar, Inc.

Historically, a shallow glidepath wins in most years

Of course, this result depends on the starting date of the comparison. What happens if we change our investor’s retirement date? To show a worst-case scenario for our investor, we changed the retirement date to February, 2009, the bottom of the last major bear market. This is the precise scenario the steep glidepath is designed to protect against and, unsurprisingly, it does, beating the shallow glidepath by about £19,000.

However, when we start rolling the investor’s retirement date forward from February 2009, we see that while the steep glidepath provided a better outcome when the investor retired at the bottom of the market, it didn’t do as well in other years. In fact, as shown in figure 4, 2009 was the only year in which the steep glidepath provided the investor with a better outcome. And in most years, the shallow glidepath beat the steep glidepath by a significant margin – by more than £15,000 in six out of nine years.

Figure 4: Shallow glidepaths almost always pay off

Shallow glidepaths almost always pay off

Notes: Shows the difference in value of a portfolio with an initial value of £100,000 invested in the shallow glidepath minus the value of a portfolio invested in the steep glidepath for the ten year period ending 28 February of each year shown. The shallow glidepath begins at 60% equities/40% bonds, ends at 50% equities/50% bonds, and is rebalanced monthly. The steep glidepath begins at 60% equities/40% bonds, ends at 0% equities/75% bonds/25% cash, and is rebalanced monthly. Equities are represented by the FTSE 100 Total Return index, bonds are represented by the Bloomberg Barclay’s Global Aggregate Total Return Hedged GBP index, cash is assumed to return 0%.

Source: Vanguard calculations using data from Morningstar, Inc.

So, to sum up, most investors who retired in the last ten years would have been better served by a long, shallow glidepath. While steep glidepaths are ideal for investors who want to take their pension in cash and/or buy an annuity and retire in a bear market, such a scenario describes very few investors, especially since the introduction of pension freedoms. Don’t let the exception guide your choice of glidepaths.

Investment risk information:

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.

Other important information:

This document is designed for use by, and is directed only at persons resident in the UK.

The material contained in this document is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.

The information in this article does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this article when making any investment decisions.

Vanguard Asset Management, Limited only gives information on products and services and does not give investment advice based on individual circumstances. If you have any questions related to your investment decision or the suitability or appropriateness for you of the product[s] described in this document, please contact your financial adviser.

The opinions expressed in this article are those of individual authors and may not be representative of Vanguard Asset Management, Limited.

Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.

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