Generating a Family of Optimal Glide Paths for Investment Planning with Target Dates

Abstract

The article presents an optimization model for an approach to financial planning whereby investment decisions over time follow a (decreasing) glide path. With this strategy, an investment advisor would recommend riskier assets for the immediate future in order to take advantage of their larger expected returns. The author presumes that, over time, the proportion of more conservative investments in the portfolio will increase. Thus, it is likely to achieve expected investment-gain targets while reducing the risk of severe losses in wealth at the time when the money is actually needed (the target dates). There are a number of benefits to front-loading investment risk in this way, even though it comes with an increase in overall risk, as measured by the variance in the random variable representing total accumulated wealth. To accommodate varying objectives among investors regarding this trade-off, the model includes a parameter for “glide-path intensity” that allows the investor to select the level of deviation from the risk-minimizing solution, which would tend to recommend investments having roughly the same risk–return level for every year in the planning horizon (i.e., a “straight-line” strategy). The model then focuses on the traditional multi-goal and multitime-horizon problem and uses simulations to demonstrate the benefits associated with a flexible implementation of the glide-path strategy that further minimizes the risk of missing a goal.

TOPICS: Portfolio construction, wealth management, risk management, simulations