Personal finance: Glide path and its types
When we think of investing, there are various investment strategies. Asset allocation is one such strategy that helps you in minimising your investment risk. Not just asset allocation but restoring the asset allocation periodically by re-balancing is important. Based on the principles of asset allocation, glide path strategy is formed. So, let’s find out what is glide path and what its types.
What is glide path?
Glide path is a strategy that is used for calculating the asset allocation for various investment portfolios allocated to different financial goals. The asset allocation is nothing but an individual portfolio’s percentage mix of equity, debt, gold, cash and any such asset classes. Thus, there are majorly three types of glide paths, which are explained in coming paragraphs.
Static glide path
Static glide path is something where the investor continues with the same initial target asset allocation but periodically, rebalances the portfolio to restore the target allocations.
Say for instance, an asset allocation with 60 per cent equity and 40 per cent debt. There might be times when equity will outperform debt or vice versa. This will skew the allocation either toward equity or debt by the end of the year.
So, with static glide path strategy, the investor will restore the initial asset allocation to the original target of 60 per cent in equity and 40 per cent in debt. Static glide path is one of the basic strategies.
Declining glide path
With declining glide path, a classic formula of 100-age = stock allocation is used to determine the asset allocation. This means that, a 30-year-old investor would have an asset allocation of 70 per cent in equity and 30 per cent in debt. However, to account for a longer life expectancy, another formula of 100-age + 14 = stock allocation is used.
Similarly, a 30-year old investor’s allocation will be 84 per cent in equity and 16 per cent in debt. At the age of 31, the allocation would be 83 per cent in equity and 17 per cent in debt. Here, re-balancing of portfolio happens automatically as your asset allocation changes annually and has to make changes accordingly. This is the most common strategy used to achieve financial goals.
Rising glide path
Rising glide path is the least commonly used glide path type. Here, the asset allocation starts with heavy allocation towards debt and gradually shifts more towards equity. For instance, an allocation of 60 per cent in debt and 40 per cent in equity might change to 60 per cent in equity and 40 per cent in debt. This is not an ideal way of managing your money. Therefore, it should be avoided.