Defined Contribution Plan Sponsors

The Adaptive Glidepath: The Case for Asset Allocation Flexibility

Typical glidepath construction today fails to account for the reality that people retiring in different time periods can have dramatically different investment return experiences, retire in market environments with different valuations, and have different retirement investment objectives. In the chart at right, we compare the experiences of a 1980 retiree, coming off a 10-year period with essentially a 0% trailing real equity return, with those of a 2000 retiree, coming off a 10-year period with a 14% trailing real equity return.

We assume the 1980 retiree would have had below-average retirement savings and needed to spend 8% of retirement assets annually to meet living expenses. At the time, the market was trading at a long-term P/E ratio of 9, well below the historical average of about 15. To sustain an 8% spending rate for 30 years, the 1980 retiree would have required an average annual real return of nearly 7%.

With the 2000 retiree, on the other hand, we assume above-average savings and a 4% spending rate. In 2000, the market was trading at a long-term P/E ratio of 34, or roughly twice the average. To sustain a 4% spending rate for 30 years, the 2000 retiree would only have required an average annual real return of approximately 1%.

Clearly, these two individuals would require substantially different asset mixes, and yet most glidepaths would treat them the same. We'd suggest the solution is asset allocation flexibility: active management of the glidepath based on risk levels, valuations, and, implicitly, the return pattern an individual has experienced.