A glide path shifts a portfolio towards less-risky assets over time by varying the asset allocation. As goals come closer, it is very risky to keep investing in the same equity to debt mix as in the beginning. The corpus size is large and any market fall will wipe out years of compounding close to the goal. This is because just having a SIP does not really reduce risk and give returns as expected. See the following example of the effect of a portfolio with SIP investments over time due to market fall.
What is a glide path?
As goals come closer, you need to reduce the proportion of risky assets like equity and shift it to safer ones like debt. The figure above shows a simple example for a 25-year goal with equity proportion starting at 60% (debt = 100% - equity) that starts to reduce when 15 years are left. When 5 years are left, the portfolio shifts completely to debt funds. Why we choose 5 years for exiting equity is explained here: How many bear markets have we seen in India?.
Read more on how to choose equity and debt funds suitable for your goals.
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How to fix the glide path?
The suitable equity to debt mix that you need to have every year for each goal can be found via risk profiling](/blog/riskProfiling.html). We cover why risk needs to reduce overtime by looking at the three factors that impact risk profile:
Need to take Risk: As the goal comes closer one of two things happen: if the goal is on track then it is good and the monthly SIP amount will need a slight increase. If not then the SIP amount needs to be increased a lot more to ensure the goal is not missed. In either case, the equity component should not be increased since that increases risk without guaranteeing an increase in return. If the SIP amount cannot be increased, then the goal horizon needs to be pushed by a few years or a loan needs to be taken at the end of the period.
Risk-taking ability: Factors like high income, less number of dependents, large corpus and high skill-set in career etc increase the ability to take more risk. When these change over time, the ability to take risk will also change.
Risk-taking willingness: This is impacted a lot by recent market performance. In a bull market, many people intend to take more and more risk while the opposite happens in a bear market. This needs to be carefully balanced with the above two factors to see unnecessarily high/low risk is not being taken.
Once you know the asset allocation for the goal that is to be followed this year, please trigger rebalancing to ensure you reach the target weight.
The table shows a typical single-payment goal and the effect of the glide path over the period and how risk is managed. For example, the -48% equity return in year 18 has no impact on the goal since the portfolio is completely moved out of equity at this point. On the flip side, the 46% return in Year 13 has limited impact on the portfolio since only 18% of the portfolio is in equity at this point. The process of reducing the equity allocation over time prevents extreme events of both types once the corpus has become large. More details are available here: What is the lifecycle of a goal?.
How many kinds of glide-path are there?
There are multiple types of glide paths depending on the three risk factors described above and the examples are given in the above image. In each chart overall portfolio risk is plotted against the passage of time. For example:
a must-have goal with low-risk ability and willingness needs to reduce equity proportion fairly quickly compared to when the ability is high
a should have a goal with high ability and willingness that allows more risk to be taken and can be in equity for higher amounts of time
a low priority/could-have goal is most flexible and potentially allows staying in risky assets longer
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This post titled Your portfolio needs a glide path: what, why and how? first appeared on 26 May 2021 at https://arthgyaan.com
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