THE ESSENTIAL GUIDE TO TARGET DATE FUNDS

ALL TARGET DATE FUNDS ARE NOT CREATED EQUAL…

Target date funds are a revolutionary idea: A single investment that evolves over time according to the changing needs of participants. The power of that idea can be seen in their rapid growth and status as a Qualified Default Investment Alternative.

But as plan sponsors embraced target date funds, they often didn’t recognize how dramatically funds—even those sharing the same target date—can differ. Nor did they recognize the significant impact those differences could have on whether participants can reach their retirement savings goals.

So, yes, all target date funds are not created equal—and with the proliferation of funds and customization options, the differences are more profound than ever. But that’s good. It means you have choices, provided you understand the differences and can use them to your advantage. Choice, however, brings risk, leaving you with an increased fiduciary responsibility to make sure the fund you choose aligns with your plan’s goals and objectives.

This guide is designed to help you understand the bottom line on target date funds. There are many approaches to delivering retirement outcomes. What’s essential is that you understand what you’re getting and whether or not it delivers what you want to your participants.

Know Your DestinationYOUR OBJECTIVE SETS THE COURSE

1

Imagine a 45-year-old participant. She’s in mid-career and has her 401(k) assets in a 2035 target date fund. Now imagine explaining to her what she should expect as the calendar zeros in on her target year. Would she be more concerned with protecting what she’s earned, or should she still be focused on maximizing her savings through investing? Or is it somewhere in between?

As defined contribution professionals, we think of retirement in terms of economic forecasts, market access, and risk. But for participants, it is much more emotional. Your target date fund’s objective will have a major impact on everything from how secure participants feel as they approach retirement, to how much they can spend once they get there.

THE BOTTOM

LINE Think about what you want for your participants and define your objective explicitly. Do you want less risk exposure (especially nearing retirement) to preserve savings? Or is your goal to help them maximize every dollar invested? Capture your plan’s objective in the Investment Policy Statement and work with your target date provider to ensure your fund matches your vision.

Different Objectives, Different ResultsIf every target date fund with the same target year had the same objective, their performance would be similar. But as the chart shows, that’s not the case. The spread between the highest and lowest returns—reaching its peak in 2008 and 2009—is clear evidence that not all target date funds are created equal.

ANU

AL R

ETU

RN

50%

25

-25

-50

0

3.094.11

0.39-4.34

-2.22

-9.23

23.75

11.76

6.10

6.25

2.84

11.57

31.4

9.5314.42

6.272.90 -9.11

-41.22

14.47

5.43

6.30

-2.44

7.34

YEAR/NUMBER OF FUNDS

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20115 6 7 11 15 21 27 33 39 43 43 44

2010 TARGET DATE FUND RETURN SPREADS

Source: Morningstar.

2

Consider our 45-year-old participant. At 25, she had little invested in her 401(k) and had many years ahead to absorb market volatility. At 65, she will have accumulated the bulk of her savings and will soon begin to draw on that savings for income. Your target date fund has to meet your vision for her at every stage of her career.

The target date fund’s glidepath maps the mix of asset classes that will bring her from the start of her career into retirement. It sets the equity percentage at the beginning and the landing point at the end. It sets the rate at which fixed income and inflation-fighting asset classes replace equities as the fund ages to maturity. Your glidepath needs to achieve your fund objective and shape your participants’ experience along the way.

Planning the JourneyTHE GLIDEPATH MANAGES THE RIDE

THE BOTTOM

LINE There are three key decisions when building the glidepath: the equity percentage for the longest dated funds, the final equity landing point and the rate at which the equity percentage declines. Work with your provider to understand how the glidepath sets out to achieve your plan’s objective and what your participants can expect at each stage of their careers.

Putting the Objective into Action

Target date funds need to manage market risk, inflation risk and longevity risk across decades of retirement savings and spending. But different funds take different paths to their target year. Below are glidepath risk levels for several leading funds. It is important to understand that different glidepaths can have very different risk levels at the same point in the journey.

14%

12

10

8

6

4

2

YEARS TO RETIREMENT

EXPE

CTED

AN

NU

ALIZ

ED R

ISK

(%)

-40 -35 -30 -25 -20 -15 -10 -5 0 +5 +10 +15

RETIREMENT

SAME TARGET YEAR, DIFFERENT GLIDEPATHS

Source: BlackRock.

Winding Down The GlidepathAs our participant moves throughout her career, her human capital—that is, her potential future earnings—will wind down, replaced by her accumulated savings. That savings will have to support decades of retirement spending. How does the glidepath take this transition into account?

All target date funds reduce risk exposure as participants move through their careers. As the illustration on the previous page makes clear, however, they do so at very different rates. Risk exposure in late career and into retirement is one of the most important areas where differences in objectives can be seen, with objectives centered around supporting retirement savings generally having lower equity exposure than those seeking to maximize investment.

An even more critical question—one increasingly at the center of today’s retirement conversation—is what your plan’s role should be in turning savings into food, shelter and living expenses in retirement. A glidepath designed to meet a sustainable withdrawal rate of, for example, 4 to 5% annual real drawdown over thirty years will need a balance of growth exposure, diversification and inflation protection through real assets. Your participants’ appetite for volatility will also need to be considered when choosing a glidepath.

Protecting Retirement Savings

A higher level of equity exposure near the target date can result in negative surprises that undermine retirement savings. For example, many 2010-dated funds experienced dramatic losses during the financial crisis because they held high levels of equities at or near the retirement target date—a time when participants needed to protect their savings the most.

0%

-2

-4

-6

-8

-10

-1220% 30% 40% 50% 60% 70%

EQUITY ALLOCATION

2-Y

EAR

AN

NU

ALIZ

ED R

ETU

RN

2010 Target Date Fund Return

NEGATIVE SURPRISES: 2010 TARGET DATE FUND RETURNS (2008–2009)

Source: Morningstar.

Check the Engine ASSET ALLOCATION DRIVES YOUR TARGET DATE FUND

3

Once upon a time, the opportunity set of asset classes available to participants was relatively small. Over the last decade, however, asset classes previously only available to sophisticated institutional investors have become accessible to individuals. These new choices require expertise and perspective to determine which are investable, additive, and can be implemented in a cost-effective manner to improve outcomes.

Take a deep look inside the fund’s underlying building blocks to determine the depth of diversification they provide—and how the pieces, including equities, fixed income and real assets combine into an efficient, powerful engine driving toward your objective.

THE BOTTOM

LINE Effective asset allocation requires a robust process that identifies the right building blocks to drive performance over a long time horizon and produce consistent results. You also need to understand how all the parts of the asset allocation engine work together.

Diversification: Is More Always Better?

Does adding a new asset class always improve diversification? Not necessarily. As the chart shows, the improvement provided by increasing diversification tends to diminish at a certain point. A carefully constructed asset allocation takes into account the complexity, expense and impact on performance that each new asset class brings.

SECURITIES IN PORTFOLIO

TOTA

L PO

RTF

OLI

O V

ARIA

NCE

1 4 8 12 16 20 30 50 150 300 500 9000

10

20

30

40

50%

70040020010040

Expected Portfolio Variance

LIMITS OF DIVERSIFICATION

Source: Elton & Gruber For Illustration Only

Your target date fund objective, glidepath and asset allocation are the most important elements in driving investment outcomes. But the way you deliver target date funds to your participants can also have an impact on participants’ savings and outcomes over time.

Index or Active ManagementThe decision whether to use index or active asset class management depends, in part, on your investment philosophy. Do you have a conviction that active management can generate better-than-market returns over time, or do you believe that capturing the market as efficiently as possible is the best way to generate long-term returns? Or, do believe a mixture of active and index management makes the most sense?

4 Fine-Tune the Ride EFFECTIVE IMPLEMENTATION CAN IMPROVE PERFORMANCE

THE BOTTOM

LINE Finally, choose a guide who knows the way. An important part of the target date selection process is deciding who will help navigate the path for your participants’ retirement journey. Target date fund managers differ widely in their experience, capabilities, and resources, so it’s key to select a team that understands your needs and objectives, and can proactively bring perspectives and expertise to the table that you cannot find in-house.

Strategic or TacticalGlidepaths are typically based on long-term strategic economic forecasts. Allowing adjustments to the glidepath to capture near-term market movements can add returns, but can introduce additional risk. If you are exploring tactical glidepath or asset class management it is critical to understand how, why and when adjustments can be made—and whether the approach makes sense for your objective.

Collective Trust Funds or Mutual FundsCollective trust funds (CTFs) leverage economies of scale and can reduce expenses for DC plans of sufficient size. CTF agreements may also permit a wider range of instruments and strategies than some mutual funds. On the other hand, mutual funds offer greater transparency that makes them the preferred choice for many larger plans.

Special Investment or Participant NeedsUnique participant demographics or specific investment beliefs may be addressed through customization, or through the addition of specialized asset classes. Guaranteed retirement income can also be generated through specialized solutions.

T O L E A R N M O R E A B O U T H O W T O N A V I G A T E T H E N E W W O R

IT’S A NEW WORLD OF INVESTING

With the retirement futures of so many participants in your hands, selecting the right target date fund is now more important than ever. You need to rely on intelligent solutions that are designed to help participants navigate today’s uncertain world and can adapt to continuing changes in the markets.

ARMED WITH THE RIGHT QUESTIONS, YOU CAN SIFT THROUGH THE UNIVERSE OF TARGET DATE FUNDS AND FIND THE RIGHT CHOICE FOR YOUR PARTICIPANTS.

Who Is BlackRock DC?Many of the world’s largest DC plans trust BlackRock with their participants’ retirement futures. As an independent, global defined contribution investment-only provider, BlackRock DC provides a breadth of capabilities and depth of knowledge across asset management, plan design, client engagement and participant communications. Our dedicated DC professionals work with plan sponsors, consultants and financial advisors to share the best thinking from across the globe for objective insights on the ever-evolving challenges of this new world. BlackRock aims to help you bring clarity to the most complex retirement plan objectives, so that together we can deliver the best possible outcome for participants.

KEY FACTS

Three decades of DC experience

Invented the industry’s first target date fund in 1993

Work with 50% of the top 200 US DC plans

More than 80 dedicated DC professionals

Fiduciary responsibility over every dollar invested through our plans

O R L D O F R E T I R E M E N T , V I S I T W W W . B L A C K R O C K . C O M / D C

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