The unique value of Target-Date Funds

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1 The unique value of Target-Date Funds By Jake Gilliam, Senior Multi-Asset Class Portfolio Strategist supporting Charles Schwab Investment Management September, 2015 Target-Date Funds are excellent low-maintenance retirement investment vehicles that have been developed to assist investors as they save for retirement. Unlike traditional balanced or risk based models, Target-date funds ( TDFs or funds ) automatically adjust their asset allocation to reduce levels of risk against a pre-selected target date aligned with the investor s anticipated retirement time horizon. TDFs typically use a wide variety of asset classes to diversify the portfolio including domestic and international equity, fixed income, real estate and commodity strategies. By rebalancing assets to be more conservative as retirement approaches, the funds are well-suited for those looking to maintain broad diversification while managing investment risk as they age. Since the role of TDFs is often the subject of much conversation and press, in this paper, we will highlight the broad benefits they have provided to investors in various stages of life. Helping investors accumulate wealth for their retirement is a key priority for Schwab. Whether through a TDF that shifts investment allocations throughout an investor s lifespan or personalized advice found in a managed account, we believe that providing solutions to support investors retirement planning is paramount for their financial success.

2 Maintaining assets for retirees Older investors During the 2008 financial crisis, TDFs closer to their target date, such as 2010 and 2015 funds, were criticized because they lost money, but they were not alone. The financial crisis was challenging for most retirement vehicles with market exposure virtually all managed accounts, risk based portfolios and balanced funds were down. Yet, because of their design, 2010 and 2015 funds typically lost much less than the rest of the market, protecting retirement assets much better than broad market indices did for a retiring investor. It is important to remember that measuring TDF results over a one-year period, like many did in 2008, is not a useful exercise for an investment solution intended to help investors throughout their lifetime. Evaluating TDFs results over a long-term view is critical. As illustrated by a hypothetical investment of $100,000 in the chart below, on average, TDFs have grown significantly, with lower volatility as overall markets have rebounded from the 2008 crisis. Although 2010 TDFs in aggregate have not fully kept pace with S&P 500 returns, lower volatility has helped 2010 Fund investors stay the course with their investments, avoid selling at market lows and benefit from a broad recovery in the markets. Those investors who have held on to these funds or slowly began taking withdrawals, as many funds were intended, have typically been well rewarded for their diligence. And that is the goal for investors. Start Standard Deviation* Schwab Target 2010 (SWBRX) $100,000 $76,310 $88,459 $97,269 $99,798 $109,419 $119,988 $126, % Fidelity Freedom 2010 (FFFCX) $100,000 $74,680 $93,216 $104,075 $103,784 $114,608 $127,307 $133, % T.Rowe Price Retirement 2010 (TRRAX) $100,000 $73,290 $93,775 $105,684 $106,255 $119,473 $133,726 $140, % Vanguard Target Retirement 2010 Inv (VTENX) $100,000 $79,330 $94,657 $105,476 $109,030 $120,064 $130,990 $138, % Morningstar Category Average $100,000 $77,540 $94,924 $105,062 $106,018 $116,207 $125,852 $129, % S&P 500 Index Total Return $100,000 $63,002 $79,675 $91,677 $93,613 $108,595 $143,766 $163, % Initial 2010 Target Investment Funds lost less Older investors still made money with less volatility The above chart illustrates a hypothetical investment of $100,000 invested in each of the listed 2010 funds as of the close of business December 31, Source: Morningstar. Competitors selected for comparison based upon high market share and/or overall public recognition. Fund and category returns are net. S&P 500 Index returns are gross of fees. Past performance is no guarantee of future results. Investment return and principal value will fluctuate, and shares, when redeemed, may be worth more or less than original cost. Fund performance includes the reinvestment of all income and is presented net of all fees. The values of the target funds will fluctuate up to and after the target date. There is no guarantee the funds will provide adequate income at or through retirement. Diversification and asset allocation strategies do not ensure a profit and cannot protect against losses in a declining market. The Funds are subject to market volatility and risks associated with the underlying investments. Risks include exposure to international and emerging markets, small company and sector equity securities, and fixed income securities subject to changes in inflation, interest rates, market valuations, liquidity, prepayments, and early redemption. The funds are built for investors who expect to start gradual withdrawals of fund assets on the target date, to begin covering expenses in retirement. The principal value of the funds is not guaranteed at any time, and will continue to fluctuate up to and after the target date. *Standard Deviation quantifies how much a series of numbers, such as fund returns, varies around its mean, or average.

3 Asset accumulation for younger investors Younger investors On the other end of the spectrum, TDFs further from their target date, such as 2040 funds are intended for younger investors. These funds are typically designed for investment growth and supporting wealth accumulation for a retirement date many decades in the future. Accordingly, given their higher equity allocations, 2040 funds may more closely track with the S&P 500 Index results both in market gains and corrections. But, as they also generally hold at least some bonds and cash investments to help maintain diversification and manage potential volatility, they may not fully keep pace with an all equity index in a strong bull market, like the one we have been experiencing since early This is not to say they are not doing what they were designed to do. The chart below illustrates a hypothetical investment of $100,000 before the last financial crisis and six years later, well into the market recovery at the end of This is a reasonable test of a full market cycle as it includes some of the best and worst annual returns the market has ever seen. At the bottom of the list is an investment in an all-equity portfolio represented by the S&P 500 Index. Start Standard Deviation* Schwab Target 2040 (SWERX) $100,000 $68,842 $88,770 $101,992 $100,216 $116,628 $146,745 $156, % Fidelity Freedom 2040 (FFFFX) $100,000 $61,198 $80,567 $92,343 $88,065 $100,864 $122,094 $129, % T. Rowe Price Retirement 2040 (TRRDX) $100,000 $61,150 $85,043 $99,082 $95,627 $112,407 $141,550 $150, % Vanguard Target Retirement 2040 Inv (VFORX) $100,000 $65,468 $84,010 $96,756 $94,292 $108,962 $135,522 $145, % Morningstar Category Average $100,000 $62,063 $81,241 $92,916 $89,669 $102,795 $123,327 $129, % S&P 500 Index Total Return $100,000 $63,002 $79,675 $91,677 $93,613 $108,595 $143,766 $163, % Initial Investment Older investors still made money with less volatility The above chart illustrates a hypothetical investment of $100,000 invested in each of the listed 2040 funds as of the close of business December 31, Source: Morningstar. Competitors selected for comparison based upon high market share and/or overall public recognition. Fund and category returns are net. S&P 500 Index returns are gross of fees. Past performance is no guarantee of future results. Investment return and principal value will fluctuate, and shares, when redeemed, may be worth more or less than original cost. Fund performance includes the reinvestment of all income and is presented net of all fees. The values of the target funds will fluctuate up to and after the target date. There is no guarantee the funds will provide adequate income at or through retirement. Diversification and asset allocation strategies do not ensure a profit and cannot protect against losses in a declining market. The Funds are subject to market volatility and risks associated with the underlying investments. Risks include exposure to international and emerging markets, small company and sector equity securities, and fixed income securities subject to changes in inflation, interest rates, market valuations, liquidity, prepayments, and early redemption. The funds are built for investors who expect to start gradual withdrawals of fund assets on the target date, to begin covering expenses in retirement. The principal value of the funds is not guaranteed at any time, and will continue to fluctuate up to and after the target date. *Standard Deviation quantifies how much a series of numbers, such as fund returns, varies around its mean, or average.

4 Long term investors holding 2040 TDFs have benefitted significantly by maintaining their investment throughout the market downturn and subsequent rebound. Most investors in these funds also continued to make additional investments, adding to their TDF holdings at lower prices during the market crisis, and ultimately improving their long-term retirement prospects. Conversely, many investors attempting to go-it-alone fled equities, locked in losses, and missed participating in the strong rebound posted by the S&P 500 Index and many long-term TDFs. Considering these performance illustrations, the funds overall ease of use and decreasing cost over the last five or six years, TDFs can be ideal for a broad range of investors. Perhaps one of their best attributes is giving beginning and older investors without access to a financial advisor an easy first step into investing. In fact, regardless of age, TDFs can be an excellent option for anyone without access to personalized advice. For those in workplace retirement plans, this can be a strong benefit. Achieving positive outcomes Investing in TDFs presents a significant opportunity for improving young investors odds of a successful retirement by redeploying savings into a long-term solution. Having experienced the financial crisis, younger investors are increasingly cash-oriented and conservative. A recent UBS Investor Watch Study (1Q 2014) reveals those in their early-to-mid thirties with at least $100,000 to invest keep an average of 42% of it in cash. Target-date funds can be a much better option than cash over the long term. For younger, risk-averse, or less experienced investors, TDFs can be a great choice because of their straightforward, TDFs may still make good sense for older investors as well, particularly those that do not have access to a personal financial advisor who can build a diversified retirement portfolio. understandable philosophy, onestop diversification and ongoing rebalancing. Compared to the current near zero-percent-yield on cash investments, a modest 6% return on a TDF over the average working career could result in a significantly larger nest egg. Holding higher amounts of cash and conservative investments that do not earn more than inflation can make retirement difficult compared with the potential returns of a more diversified TDF portfolio. Even though younger investors may have smaller investments, TDFs offer a broadly diversified and professionally managed strategy, which can help younger investors get started. Likewise, TDFs may still make good sense for older investors as well, particularly those that do not have access to a personal financial advisor who can build a diversified retirement portfolio. Older investors not only continue to benefit from the built-in diversification, but also the gradual and systematic conservative shift of the portfolios over time. While they do not guarantee an income stream for life, most of the products are structured to help provide income well into retirement. As shown in the previous charts, those who have stayed in these funds since the financial crisis including those near retirement have not only made up their losses but have been able to grow their retirement savings.

5 Market acceptance The market is choosing TDF products. According to Morningstar, TDF mutual funds crossed the $500 billion threshold in 2013, not counting hundreds of billions in other TDF collective trust and separate account vehicles. Advisors, 401(k) plan sponsors, and their participants are also choosing TDFs because of their ease of use. In fact, industry studies have shown plan sponsors are choosing TDFs as their plans Qualified Default Investment Alternative (QDIA) in over 70% of plans. In some of these cases, if employees do not make an investment choice regarding their plan assets, they will be invested in a target date fund as a QDIA. Furthermore, many plans are taking things a step further with a process known as re-enrollment. Typically during a re-enrollment, unless an employee chooses otherwise, their entire retirement plan balance is transferred from current investments to a TDF based on their age. These trends toward TDFs as QDIA, and as a re-enrollment destination clearly show the confidence fiduciaries have in making these vehicles available for their employees. Finally, TDFs have continued to experience positive flows year in and year out, signaling continued confidence and acceptance of these products by both retirement plan decision makers and investors. Until recently, money has been consistently leaving equity mutual funds, whereas TDFs have experienced continued positive cash flow and assets under management are growing steadily. Over 75% of Q defined contribution plan net flows went into TDFs, according to Callan Associates DC Insights, Q TDFs can provide good value to investors of every age. When comparing them to other investments, it is critical to fully consider their structure and take a longer-term view on their performance. For those looking for a professionally managed vehicle and who do not have access to personalized advice up to and through their retirement years, target-date funds are a great choice. TDFs have continued to experience positive flows year in and year out, signaling continued confidence and acceptance of these products by both retirement plan decision makers and investors.

6 Jake Gilliam CFA, AIF Senior Multi-Asset Class Portfolio Strategist Charles Schwab & Co., Inc. Jake Gilliam is the Senior Multi-Asset Class Portfolio Strategist for Charles Schwab & Co., Inc. supporting Charles Schwab Investment Management s (CSIM) Asset Allocation and Sub-Advisor Oversight Committees. He contributes to strategic decisions for all multi-asset class portfolios as well as several single asset-class portfolios within CSIM and Schwab Bank Collective Trust Funds. He works closely with the Chief Investment Officers, Portfolio Managers, Research, and Sub-Advisor Oversight teams on a frequent basis. Mr. Gilliam also represents CSIM s multi-asset class strategies to the institutional marketplace, clients, and the media. Previously, he was the day-to-day Senior Portfolio Manager for Schwab Bank s Collective Trust Funds and Head of Sub-Advisor oversight for CSIM. Additionally, Mr. Gilliam served as interim Head of Asset Allocation and Portfolio Manager for CSIM s Multi-Asset Class funds. Additionally, Mr. Gilliam developed the Schwab Corporate and Retirement Services Institutional Investment Analyst team and oversaw the due diligence process for maintaining the Schwab Focus List. Earlier in his career, he also worked as a sell-side Equity Research Associate covering the food retail and restaurant industries. Mr. Gilliam earned a Bachelor of Business Administration degree in Finance from Ohio University, and is a board member of the Ohio University College of Business Finance Advisory Council. He is a CFA charterholder and a member of the CFA Society of Cleveland. He has earned the Accredited Investment Fiduciary (AIF) designation, awarded by the Center for Fiduciary Studies, University of Pittsburgh. Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus for Schwab Funds and for Laudus Funds by visiting csimfunds.com. Please read the prospectus carefully before investing. In addition to age and anticipated retirement date, investors should consider their risk tolerance, personal circumstances and complete financial situation prior to investing in a particular target date fund. Target date fund asset allocations are subject to change over time. The principal value of the funds is not guaranteed at any time, and will continue to fluctuate up to and after the target date. There is no guarantee the funds will provide adequate income at or through retirement. The funds are built for investors who expect to start gradual withdrawals of fund assets on the target date, to begin covering expenses in retirement. Diversification strategies do not ensure a profit and do not protect against losses in declining markets. Charles Schwab Investment Management, Inc. ( CSIM ), the investment adviser for Schwab s proprietary funds, and Charles Schwab & Co., Inc. ( Schwab ), the distributor for Schwab Funds, are separate but affiliated companies and subsidiaries of The Charles Schwab Corporation. This information is being furnished as educational and is not intended to constitute investment advice. Readers are expected to consult with their legal or financial advisors as applicable. The material in this presentation is based on information from a variety of sources we consider reliable, but we do not represent that the information is accurate or complete. Errors and omissions can occur. None of the information constitutes a recommendation by Charles Schwab Investment Management, Charles Schwab Bank, or their affiliates or a solicitation of an offer to buy or sell any securities Charles Schwab & Co. Inc. All rights reserved. Member SIPC. REF ( ) MKT (09/15) DST000000