Glide paths and lifecycle allocation: human capital as a bond and why the path should bend
Derive an equity glide path from the value of your future earnings, see why the path is flat for decades and then falls, and adjust it for a job that behaves like a stock.
What you will learn
- What a glide path is and how target-date funds use one.
- How to value human capital as a bond and include it in the allocation.
- Why a sensible glide path is flat for decades and then bends down.
- How a stock-like job changes the answer.
Explanation
A glide path is a rule that sets the equity share as a function of age or years to a goal. Target-date funds (funds named after a retirement year, such as "2055") follow a published one: high equity when the owner is young, then a gradual reduction. The old rule "equity share = 100 minus age" is a linear glide path, and linearity is exactly what this lesson questions.
The idea behind every glide path is human capital: the present value of all the salary you will still earn. For most employees future salary is fairly stable and only loosely linked to the stock market, so it behaves like a large, non-tradable bond. Bodie, Merton and Samuelson (1992) formalised this: total wealth is financial wealth plus human capital, and the equity share that matters is the share of total wealth.
The consequence is mechanical. At 30, human capital dwarfs the brokerage account; to reach, say, 40 percent equities in total wealth you would need far more than 100 percent of the financial portfolio in stocks. Without leverage (lesson 11) you cannot, so the path is capped at 100 percent and stays there for decades. Only when the human-capital "bond" shrinks towards retirement must the financial equity share fall, and then it falls quickly. The path bends; it is not a straight line.
A second reason to bend late is sequence-of-returns risk: a large loss just before or after retirement hurts most because the portfolio is largest and withdrawals start. The decumulation side (rising equity glide paths, the "bond tent") is covered in the course "Living Off a Portfolio"; here we stay on accumulation.
Human capital is not always bond-like. A commission-paid salesperson in a cyclical industry, a founder, or an employee whose bonus and job security move with the market owns partly equity-like human capital. That part already counts as equity exposure, so the financial portfolio should hold less equity than the standard path suggests. Statutory pension claims are a further bond-like asset; we leave them out, which makes the example conservative.
Worked example
Hypothetical example: an employee earns €50,000 net per year in real terms and retires at 65. We discount future salary at 3 percent real with the ordinary-annuity formula and target 40 percent equities in total wealth. Taxes, pension claims and salary growth are excluded.
Present value (PV) of human capital = 50,000 × (1 − 1.03^(−n)) / 0.03, where n is the number of working years left.
| Age | Years left | PV of human capital | Financial assets | Total wealth | 40 % of total | Required equity share of financial assets |
|---|---|---|---|---|---|---|
| 30 | 35 | €1,074,361 | €60,000 | €1,134,361 | €453,744 | 756 % → capped at 100 % |
| 45 | 20 | €743,874 | €250,000 | €993,874 | €397,549 | 159 % → capped at 100 % |
| 55 | 10 | €426,510 | €500,000 | €926,510 | €370,604 | 74 % |
| 65 | 0 | €0 | €700,000 | €700,000 | €280,000 | 40 % |
Step for age 55: 426,510 + 500,000 = 926,510; 40 percent of that is 370,604; divided by 500,000 gives 74.1 percent. The path is 100 percent until well after 45, then 74 percent at 55 and 40 percent at 65: flat, then a steep bend over the last ten to fifteen years.
Stock-like job variant: assume 30 percent of the human capital is equity-like. At 45: 0.3 × 743,874 = €223,162 already counts as equity, so required financial equity = 397,549 − 223,162 = €174,387, or 69.8 percent of €250,000 instead of 100 percent. At 55: 0.3 × 426,510 = €127,953; 370,604 − 127,953 = €242,651, or 48.5 percent instead of 74 percent. Same person, same risk target, a lower path.
Common mistake
Practice activity
On paper: a 40-year-old earns €60,000 real per year, retires at 67 (27 years left), has €180,000 in financial assets, discounts at 3 percent real and targets 45 percent equities in total wealth. (a) Compute the PV of human capital and the required financial equity share if the job is fully bond-like. (b) Repeat with 50 percent of human capital equity-like. Use 1.03^(−27) ≈ 0.4502.
Show solution
(a) PV = 60,000 × (1 − 0.4502) / 0.03 = 60,000 × 18.327 = €1,099,600 (rounded). Total wealth = 1,099,600 + 180,000 = €1,279,600. 45 percent of total = €575,820. Required share of financial assets = 575,820 / 180,000 = 320 percent, capped at 100 percent equities.
(b) Equity-like human capital = 0.5 × 1,099,600 = €549,800. Required financial equity = 575,820 − 549,800 = €26,020, or 14.5 percent of €180,000: mostly bonds and cash, because the job already carries the equity risk.
Limitations: discount rate, human-capital split and target are assumptions; pension claims, salary growth, job-loss risk and taxes are excluded.
Key takeaways
- Human capital is the present value of future earnings; for most employees it behaves like a large bond.
- Because it dominates early, the financial equity share is capped at 100 percent for decades and bends down over the last ten to fifteen years.
- Equity-like human capital (cyclical, commission-based or founder income) lowers the whole path.
- Write your path in a table by age; revisit it when your income type changes.
Next step
Next we test which diversifiers, from gold to managed futures, actually reduce portfolio risk at realistic weights, and when that benefit fails.
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