Rethinking

Target-Date Fund Design:

Managing Participant Risks

Srinivas D. Reddy, CFA Clint Barker, CIMA Stephen Brundage, CFA

Senior Vice President Senior Vice President Managing Director
Full Service Investments Retirement Investment Solutions Quantitative Management Associates
Prudential Retirement Prudential Investments LLC

0000000
 Introduction
Americans are anxious about retirement, a fact that should come as no surprise. A 2014 study by Prudential revealed
that to “not run out of money in retirement” was the top financial goal for 75% of respondents—higher even than being
able to afford medical care.1 More telling was that of these respondents, only about one third were confident in their
ability to meet this goal.2 Similarly, a 2013 National Institute on Retirement Security (NIRS) study found that 85% of
those surveyed were concerned about their retirement outlook.3

Exhibit 1 Retirement Confidence

6%
8%

55% Very concerned

30% Somewhat concerned
55%
8% Not too concerned
30%
6% Not at all concerned
Source: NIRS 2013 Opinion Research

Many Americans are facing a potential retirement income gap—a 2014 Prudential Retirement® Financial Literacy and
Retirement Readiness Study found that most employees are falling short in saving what they need for retirement4—
and a variety of solutions are being contemplated both in Washington DC and in the private sector to help solve this
“retirement crisis.” For example, features such as auto-enrollment and auto-escalation have been implemented in
many defined contribution plans to help combat participant inertia. These features make it increasingly important for
plan sponsors to choose a qualified default investment alternative (QDIA) for participants who do not otherwise make
an investment selection. Target-date funds (TDFs), which attempt to put participants in an appropriate asset allocation
mix and glidepath based on their estimated retirement date, have become an increasingly popular option—especially
as a QDIA—due to their design and ease of use.

75% “Not running out of money in retirement”

of respondents rank

as top concern.
Prudential Retirement, Financial Literacy and Retirement Readiness Study, 2014.

1
Prudential Retirement, Financial Literacy and Retirement Readiness Study, 2014.
2
Ibid
3
NIRS, “Pensions & Retirement Security 2013: A Roadmap for Policy Makers,” 2013.
2
4
Prudential Retirement, Financial Literacy and Retirement Readiness Study, 2014.
With this widespread use of TDFs, it is important for plan sponsors and other plan fiduciaries to recognize that despite
their automatic features, TDFs are not all created equal. This is precisely why in February of 2013, the Department of
Labor issued a fact sheet containing tips for ERISA plan fiduciaries on factors to consider when choosing a target-date
fund.5 Among the primary considerations for plan sponsors to evaluate are the design of the target-date fund and how
the fund construction attempts to manage various risks.

Target-Date Asset Growth (Dollars in Millions)

$800,000

$700,000
$677,243

$600,000

$500,000

$400,000

$300,000 $335,184

$200,000

$116,473
$100,000

$15,325
$9,246
$0

2000 2002 2004 2006 2008 2010 2012 Q3 2014

Source: Strategic Insight Simfund Database, Life Cycle Fund IS (Target-Date) Assets, 2000—3Q 2014

We’ve conducted significant research both on the retirement risks that Americans are facing and how TDFs can help
to mitigate those risks. The remainder of this paper will discuss this research as well as how Prudential approached the
construction of its own TDFs, the Day OneSM Fund Suite.

The target date is the approximate date when investors plan to retire and may begin withdrawing their money. The asset allocation of the
target-date funds will become more conservative as the target date approaches by lessening the equity exposure and increasing the exposure
in fixed income type investments. The principal value of an investment in a target-date fund is not guaranteed at any time, including the target
date. There is no guarantee that the fund will provide adequate retirement income. A target-date fund should not be selected based solely on
age or retirement date, is not a guaranteed investment and the stated asset allocation may be subject to change. It is possible to lose money
by investing in securities. Investments in the Funds are not deposits or obligations of any bank and are not insured or guaranteed by any
governmental agency or instrumentality.
5
“Target Date Retirement Funds–Tips for ERISA Plan Fiduciaries,” http://www.dol.gov/ebsa/newsroom/fsTDF.html, accessed July 16, 2014. 3
 A hard look at hard data
At Prudential, we are dedicated to uncovering and understanding the underlying historical drivers of retirement
unpreparedness. As part of this commitment, we conducted a detailed analysis of the actual savings and investing
behaviors of retirement plan participants. We analyzed participant savings rates and employer contribution rates from
over 850,000 participants in nearly 2,000 defined contribution plans recordkept by Prudential Retirement. We also
looked at demographic data and academic research to examine income replacement ratios that would represent the
amount of retirement income needed to maintain a pre-retirement standard of living. All of these factors are important
to creating realistic and data-driven cash flow assumptions, which we used to influence the glidepath designs and
construction. In 2009, Prudential was among the first in the industry to adopt this type of research—but it’s not the only
factor driving our target-date fund design.

We have also pioneered research on what we call The Retirement Red Zone®, the critical years prior to and just after
a participant’s target retirement date, when poor investment performance can quickly lead to negative participant
outcomes. Since developing the concept in 2005, Prudential has studied the effects of market fluctuations on investors
in The Retirement Red Zone. Our research confirms that losses in this period can have a significant impact on a
participant’s ability to retire when planned and to live comfortably throughout retirement. Poor investment performance
in The Retirement Red Zone can have a lasting effect on a participant’s investment portfolio, often leaving little time to
recover. The findings from this research further informed the construction and design of our target-date fund suite.

Finally, to complement our quantitative research, we’ve looked at the behavioral characteristics of plan participants
and focused on the choices they’ve made. We assessed attitudes concerning their likelihood of living longer, their
tendencies to procrastinate, and common behavioral biases such as anchoring and overconfidence. These insights led
us to develop unique tools that motivate and teach participants to better prepare for retirement.

And while behavioral implications are important to understand, participants still face major risks that can be addressed
through target-date fund design, such as:

•• Investment Risk—the risks associated with insufficient or inappropriate diversification/asset allocation

•• Inflation Risk—the risk that participant incomes won’t keep pace with inflation, a particularly worrisome
concern given the skyrocketing cost of healthcare
•• Sequence of Returns Risk—the risk that negative returns either just before or after retirement can have
a dramatic adverse impact on the ability of retirement savings to last throughout a participant’s lifetime
•• Longevity Risk—the risk of participants outliving their assets

While all target-date funds address some of these risks, we believe there is one risk that has been historically
overlooked yet stands out above all: longevity. For this reason, we have created our suite of target-date funds to have
two distinct glidepath designs that can help manage—or even eliminate6—longevity risk.

6
When invested and “Locked-In” to the Prudential Day One IncomeFlex Target Funds. Guarantees are based on claims-paying ability of Prudential Retirement Insurance and
Annuity Company (PRIAC), and are subject to certain limitations, terms, and conditions. Withdrawals in excess of the lifetime annual withdrawal amount will reduce further
4 guaranteed withdrawals proportionately and may even eliminate them entirely.
Constructing target-date funds that address increased longevity
In 2010, there were 5.8 million Americans age 85 or older. By 2050, that
number is projected to soar to 19 million.7 With this in mind, conventional
industry wisdom around a 20-year average retirement lifespan is simply
The first person
inadequate for long-term retirement planning. Retirement industry experts are to live to
ringing the warning bell that without a systemic change in how the industry
calculates participants’ retirement savings needs, each year more and more
individuals will be faced with the very real risk of outliving their assets.
150
is most likely
To help close this significant retirement income gap, we believe that alive today.
participants will need to plan for a lifespan that may very well extend to age Source: Forbes.com, “John Nosta: The First
Person to Live to 150 Has Already Been Born
95 or beyond. Why an additional 12 years when the U.S. Census Bureau
—Revisited!”, 2013.
estimates the average American life expectancy to be only 83 by 2050?8
Because we see an obligation to help participants prepare for the possibility of
a longer life in retirement than expected—after all, an average is just that, and
some will far surpass it.

The assessment of the TDF landscape suggests that a greater number of providers have constructed a “through”
glidepath design to help guard against longevity risk. We believe going beyond the labels and deep into glidepath
construction is necessary.

“To” Versus “Through” Glidepaths

Historically there have been two schools of thought around TDF glidepaths;

•• “To” funds, which manage the reduction of equity •• “Through” funds, which manage the reduction of equity
exposure up to the target date, when it lands at its exposure “through” retirement, continuing to decrease
most conservative point. until 10, 20, or even 30 years after the target date.

These naming conventions can be misleading, because they imply significant

simplification of a fundamentally complex concept.
For example, in broad terms “to” funds are generally perceived to have a very conservative allocation at the
target date, because it is designed to be the final equity landing point. However, if you look at the universe
of “through” funds, there are a number of them that are just as conservative in their allocations at the target
date as the “to” funds.

Rather than focusing merely on the concept of “to” versus “through,” it is important for
plan sponsors and advisors to identify the risk profile they are solving for.
Then evaluate the various target-date fund options–and the intricacies of their individual glidepaths–based
on the ability to address the needs of their plan and participants, rather than simply including or excluding
funds because of a “to” or “through” label.

7
U.S. Census Bureau, “The Next Four Decades: The Older Population in the United States 2010 to 2050,” May 2010.
8
U.S. Census Bureau, Population Division, “Projected Life Expectancy at Birth by Sex, Race, and Hispanic Origin for the United States: 2015 to 2060 (NP2012-T10C),” May 2013. 5
 The findings around longevity were factored into the construction of the Prudential Day One target-date fund suite9
in two ways and through two distinct glidepath designs.

1. The Prudential Day One Funds’ glidepath design initially has a high equity as well as non-traditional allocation to
help increase the potential for asset accumulation. Approximately 10 years prior to the target date, the glidepath
slope starts getting much steeper, transferring out of equities and into fixed income investments at a quicker pace
to reduce downside equity risk when investors can least afford to experience significant losses. This glidepath
design may allow participants an opportunity to accumulate more assets for retirement when they are younger and
can afford to take on risk, but reduces downside equity risk as they near retirement. However, while the Day One
Funds’ glidepath design is constructed to seek to mitigate longevity risk, it does not provide guaranteed income.
That is why we have also designed another version of the Day One Funds.

Ten years prior to the target date, we incorporate

The Retirement Red Zone concept into our
glidepath. At this point, we begin to significantly
shift from riskier assets to more conservative ones.

Because - 10 TARGET DATE +10

addressing 97% YEARS YEARS
longevity risk is
so important,
EQUITY & NON-TRADITIONAL EXPOSURE (%)

the glidepath 80
starts with a As the target date approaches,
97% allocation equity exposure decreases.
to domestic and
foreign equities,
as well as 60
commodities
and real estate
(non-traditional
investments) Because the Day One Funds have a “through” retirement
40
to help provide for glidepath, the exposure to equities continues to decrease to
potential growth. provide additional protection against equity market declines. 35%
This allocation stabilizes 10 years after the target date
at 25% equities, 10% commodities and real estate, and
20 65% fixed income.

YEARS TO RETIREMENT
0
-40 yrs -30 yrs -20 yrs -10 yrs +10 yrs
TARGET DATE
DAY ONE FUNDS 2060 2055 2050 2045 2040 2035 2030 2025 2020 2015 2010 Income

As shown in the chart, each target-date fund’s asset allocation follows a glidepath that becomes more conservative as the applicable target date approaches by reducing exposure
to equity investments and increasing exposure to fixed income investments. The glidepath continues to adjust allocations in this manner for approximately 10 years past the target
date, at which point the asset allocation of each target-date fund will be similar to that of the Day One Income Fund, which maintains a static asset allocation. The glidepath
assumes retirement at approximately age 65 and contributions beginning at approximately age 18.
Each Day One Fund’s underlying asset allocation is reviewed periodically to determine whether the glidepath (or, in the case of the Day One Income Fund, the prescribed asset
allocation) and underlying funds in which such Fund invests remain suitable to meet the Fund’s investment objective. As a result of this review, the glidepath and/or the allocation of
the Fund’s assets among the underlying funds may be modified.
The Day One 2010 Fund is only available as an insurance company separate account under group variable annuity contracts issued by Prudential Retirement Insurance and Annuity
Company.
Allocations as of January 2, 2015.

9
Prudential Day One Funds are offered in the following structures: (i) insurance company separate accounts available under group variable annuity contracts issued by Prudential
Retirement Insurance and Annuity Company (PRIAC), Hartford, CT, a Prudential Financial company, and (ii) collective investment trust funds established by Prudential Trust
Company, as trustee, a Pennsylvania Banking Corporation located in Scranton, PA, and a Prudential Financial company. Each of PRIAC and Prudential Trust Company is solely
responsible for its own contractual obligations and financial condition. Offers of the collective trust funds may only be made by sales officers of Prudential Trust Company.
PRIAC and Prudential Trust Company have each engaged Quantitative Management Associates LLC, an SEC registered investment adviser and a Prudential Financial company,
to perform asset allocation and certain other services. The Day One Funds, as insurance company separate accounts or collective investment trusts, are investment vehicles
available only to qualified retirement plans, such as 401(k) plans and government plans, and their participants. Unlike mutual funds, the Day One Funds are exempt from federal
6 securities laws and not entitled to the protections of those laws.Instead they are subject to regulation under applicable bank or insurance laws.
2. The Prudential Day One IncomeFlex Target® Funds (available for an additional fee) are designed to provide
guaranteed retirement income by incorporating Prudential IncomeFlex Target®, offered by Prudential Retirement
Insurance and Annuity Company.10 This glidepath design starts out in the same fashion as the Day One Funds’
glidepath but, at 10 years prior to the target date when income guarantees become active, it stabilizes at a high
allocation to equities and non-traditional asset classes (60%) and maintains this allocation beyond the target date.
This product design allows participants to maintain the high equity allocation and participate in equity rallies while
being fully protected from market decline on the downside. Research has found that as many as three out of four
participants believe traditional target-date funds already include guaranteed income.11 Given this widespread
misconception, we feel it is important to offer a product that also offers a lifetime retirement income solution.

100 -10 Target Date

97% YEARS

80
EQUITY AND NON-TRADITIONAL EXPOSURE (% )

60
60%

40

20

0
-40 yrs -30 yrs -20 yrs -10 yrs Target Date +10 yrs
YEARS TO RETIREMENT

As shown in the illustration above, each target-date fund’s asset allocation follows a glidepath that becomes more conservative as the applicable target date approaches by
reducing exposure to equity investments and increasing exposure to fixed income investments. The glidepath continues to adjust allocations in this manner until approximately 10
years prior to the target date, at which point the asset allocation of each target-date fund will be similar to that of the Day One IncomeFlex Target Balanced Fund, which maintains
a static asset allocation.
Each Fund’s underlying asset allocation is reviewed periodically to determine whether the glidepath (or, in the case of the Day One IncomeFlex Target Balanced Fund, the prescribed
asset allocation) and underlying funds in which such Fund invests remain suitable to meet the Fund’s investment objective. As a result of this review, the glidepath and/or the
allocation of the Fund’s assets among the underlying funds may be modified.
Allocations as of January 2, 2015.

10
Guarantees are based on claims-paying ability of Prudential Retirement Insurance and Annuity Company (PRIAC), and are subject to certain
limitations, terms, and conditions. Withdrawals or transfers (other than transfers between Active IncomeFlex Target Funds) proportionately
reduce guaranteed values prior to “locking-in.” After “Lock-In,” withdrawals in excess of the Lifetime Annual Withdrawal Amount will reduce
future guaranteed withdrawals proportionately and may even eliminate them entirely.
11
AllianceBernstein, 2011, “What Workers Get—And Don’t Get—About Target-Date Funds.” 7
 Hedging against sequence of returns risk
A retirement risk that is often overlooked is the
critical importance of investment returns in the
Exhibit 2 Sequence of Returns
years just before and after a participant transitions Recovering from early losses can be challenging
into retirement and begins drawing income from Hypothetical Hypothetical
Hypothetical $250,000 Hypothetical $250,000
his/her savings. While “average” returns may 4% Withdrawals
Annual Net Portfolio Value Annual Net Portfolio Value
Begin in Year 1
even out over time, they can vary widely over the Return (Negative Returns Return (Positive Returns
Early) Early)
short-term. Older participants who are closer to
Beginning Value Participant A $250,000 Participant B $250,000
retirement can’t afford the short-term losses that
1 -18.9% $194,640 15.3% $276,720
a younger participant can, because they likely will
2 -14.1% $158,842 6.1% $281,724
not have enough time to recover from them. Just 3 -4.8% $142,614 10.7% $299,636
a few years of below-average returns right before 4 5.1% $141,025 10.0% $317,001
or after a participant begins to take distributions 5 7.0% $141,769 2.0% $310,364
in retirement can quickly erode their retirement 6 14.1% $152,357 7.2% $319,343
savings to the point that they’ll be unable to 7 -4.3% $136,122 2.0% $311,963
generate enough income to last a lifetime. For 8 5.8% $134,043 5.1% $313,693
evidence, look no further than the devastating 9 15.6% $144,680 8.5% $325,751
effects of the 2008 financial crisis. 10 5.4% $141,911 14.0% $356,312
11 5.9% $139,385 4.4% $356,494
To further illustrate this point, consider the two 12 10.6% $142,933 3.6% $353,368
hypothetical scenarios depicted in Exhibit 2. Both 13 10.8% $146,807 6.2% $358,837

participants had accumulated $250,000 in savings 14 6.8% $144,880 3.8% $355,541

at retirement. Both experienced a 5% average 15 10.7% $148,115 -4.5% $322,101

annual return and took annual 4% withdrawals 16 -4.5% $128,815 10.7% $338,603

throughout the ensuing 30 years. The only 17 3.8% $120,696 6.8% $343,126
18 6.2% $114,774 10.8% $361,126
difference between the two is that Participant A
19 3.6% $105,099 10.6% $379,776
experienced negative returns during the first three
20 4.4% $85,503 5.9% $381,965
years of retirement (-18.9%, -14.1% and -4.8%),
21 14.0% $94,226 5.4% $381,767
while Participant B experienced positive returns
22 8.5% $87,148 15.6% $419,873
(15.3%, 6.1% and 10.7%) during those same
23 5.1% $76,053 5.8% $422,133
years.
24 2.0% $61,568 -4.3% $381,226
25 7.2% $49,515 14.1% $411,541
As you can see, Participant B still retained a
26 2.0% $33,525 7.0% $416,207
portfolio valued at over $207,212 after 30 years, 27 10.0% $19,387 5.1% $412,568
while Participant A ran out of retirement savings 28 10.7% $3,447 -4.8% $367,154
after 28 years. While a portfolio achieving a 29 6.1% $0 -14.1% $289,005
sufficient average annual return to meet retirement 30 15.3% $0 -18.9% $207,212
goals is important, the sequence of those returns
may also have a significant impact. Because we
Average Annual Net 5% 5%
Return for 30-Year Period
Negative Returns early Positive Returns early can extend
know the sequence of returns risk is magnified deplete savings savings more than 30 years despite
in The Retirement Red Zone, the Day One Funds the same average annual net return

reflect an accelerated shift from riskier assets

to more conservative ones, in order to coincide with the participant’s move into The Retirement Red Zone. As the
participant enters The Retirement Red Zone, 10 years before the fund’s target date, a significant shift occurs. At the
target date, there is another significant shift to more conservative assets, and the glidepath continues to shift downward
until 10 years post target date. This “kink” in the glidepath works to help manage risk by shifting from equities to fixed
assets, thereby subjecting a lesser portion of the portfolio to risk at a time when participants most need to preserve their
assets for retirement income.

8
Participants who elect the Prudential Day One IncomeFlex Target Funds gain additional protection from sequence of
returns risk once the IncomeFlex Target guarantees are activated (10 years prior to the target date). As participants
move into The Retirement Red Zone, the presence of the income guarantee allows for a greater allocation to equities
and non-traditional assets (60%) to capture market highs, but protects against sequence of returns risk at a time when
participants need to preserve their assets for retirement income.

On the day a participant decides to “Lock-In” his or her guaranteed benefit, the participant’s Market Value and Income
Base are compared (both as of the previous business day). If the Market Value is higher, the Income Base automatically
adjusts upwards to match.

A participant’s Income Base is used to determine his or her lifetime annual withdrawal amount. Prudential Retirement
guarantees that the participant can withdraw this amount each year for the rest of his or her life. Unlike Market Value,
which is available as cash or lump sum, the amount reflected as the participant’s Income Base is never available as a
withdrawal.

With Day One IncomeFlex Target Funds, participants receive downside market protection for retirement income and
income that will never decrease—even in poor markets.

Protecting against the dangers of inflation

Despite the absence of broad-based inflationary pressures in the current economic environment, the effects of even low
inflation rates can add up and compound over time to have a significant impact. Consider that over the past 30 years,
consumer prices have more than doubled. That means that participants retiring today at age 65, who could be looking
at 30 years or more in retirement, could see nearly everything they need to purchase double in cost.

Exhibit 3 Cumulative Inflation from 1984 to 2013

$24,000

$22,000
An average inflation rate of 2.8% in the last 30 years
means that prices increased 130% since 1984
$20,000

$18,000

$16,000

$14,000

$12,000

$10,000
1984 1988 1992 1996 2000 2004 2008 2012

YEAR

Source: Calculated by Prudential Investments LLC using data presented in Morningstar Software products. All rights reserved. Used with permission. Inflation is
measured by the Consumer Price Index (CPI), which is a measure of the average price of consumer goods and services purchased by households. All data as of
December 31st of each year.

9
 This exemplifies the erosive effect inflation can have on the purchasing power of retirement savings accounts. Clearly,
inflation protection is a crucial piece of the retirement income puzzle. Inflation protection can be achieved through
exposure to a variety of asset classes. Equities, for instance, have proven to be one of the best “after inflation” asset
classes but can exhibit higher volatility than some other asset classes. Equities provide relatively good inflation
protection over the long term because stock returns, with some degree of certainty, exceed the inflation rate due in
part to the high long-term equity premium. Prudential believes a diversified portfolio of “real” assets, those that have a
physical or tangible value, provides inflation protection while reducing portfolio volatility.

Treasury Inflation Protected Securities (TIPS) can play a valuable role both in protecting against the impact of potential
inflation that can arise from negative supply shocks or weak monetary policy and helping to manage downside risk.
When equity markets are crashing, investors historically have moved into “safe haven” asset classes such as treasuries.

Prudential’s research shows that by diversifying the Day One Fund suite with allocations to asset classes such as
commodities and real estate, we may be able to seek to mitigate the effects of the broad-based inflation that often
accompanies a strong global economy. As noted in Exhibit 4 below, holding a diversified basket of “real” assets may not
only help combat the impact of inflation on investment portfolios, but may also improve overall returns.

The Day One Fund suite is constructed with a portion of the allocations devoted to TIPS, commodities, and real estate
in an effort to moderate risk as well as outpace inflation during both the accumulation years and in retirement. In
addition, as the funds approach their target dates, the allocation to TIPS meaningfully increases, adding an additional
strategy to attempt to mitigate potential inflation.

Exhibit 4 Average Annual Real Returns During High Inflation

14

12.6%
12

10.8%

10
REAL AVERAGE RETURNS

7.9%
8

3.9%
4

0
COMMODITIES REAL ESTATE STOCKS BONDS

Source: Calculated by Prudential Investments LLC using data presented in Morningstar Software products. All rights reserved. Used with permission. Reflects annualized rates
of return for the high inflationary periods. High inflation periods are calendar years when inflation was 3% or more (1976–1985, 1987–1991, 1996, 2000, 2004, 2005, 2007, and
2011). Average annualized returns were calculated by taking the average of all 21 years. Real estate securities are represented by the equal portions of the FTSE NAREIT All Equity
REITs Index and the NCREIF Property Index, except for years 1976 and 1977, which pre-dates the NCREIF Property Index, thus only the FTSE NAREIT All Equity REITs Index is used.
Both indexes are unmanaged and measure the performance of all real estate. Commodities are represented by the S&P Goldman Sachs Commodity Index, which is unmanaged and
is a world-production weighted index composed of 24 commodity futures contracts. Stocks are represented by the S&P 500 Index, which is a market-weighted, unmanaged index of
500 of the largest U.S. stocks in a variety of industry sectors. Bonds are represented by the Barclays U.S. Aggregate Bond Index, which is unmanaged and covers the U.S. dollar-
denominated, investment-grade, fixed-rate, taxable bond market of Securities and Exchange Commission (SEC) registered securities. These returns do not assume share price
changes or the compounding effect of reinvested dividends and capital gains. An investment cannot be made directly in an index. Past performance is not a guarantee or reliable
indicator of future results.

10
Enhancing returns while controlling investment risk
According to Modern Portfolio Theory, the most effective way to mitigate risk is to diversify. But left to their own devices,
participants often fail to adequately diversify their retirement plan investments. For example, a 2011 Prudential
Retirement Book of Business survey found that almost 40% of DC plan participants age 50 and over who were not
enrolled in a target-date fund were invested entirely in either equity or fixed income funds. Whether due to inertia, fear,
or lack of investment knowledge, the result is the same: participants who are not diversified are taking an unnecessary
chance with their retirement savings.

TDFs are generally constructed to help correct those poor investing habits and help improve diversification, which is
one reason they are increasingly being adopted by plan sponsors. Asset class inclusion and allocation decisions for
the Day One Fund suite are based on analysis of expected returns, risks, and correlations. The specific analysis is
described below.

Exposure to emerging markets, real estate, and commodities

Here’s an example of how diversification helps. On the
Exhibit 5 15-Year Risk/Return for DM and EM
international front, our research showed that by taking
12 25% from a developed international equity allocation
and moving it to emerging markets, the portfolio’s risk as
10 measured by standard deviation went up 0.9 points (or
5%), while the overall portfolio return went up from 4.5%
to 6.3% (40% increase).
AVERAGE ANNUAL RETURN (%)

100% Developed Markets

4
75% Developed Markets / 25% Emerging Markets
100% Emerging Markets
2

Source: Calculated by Prudential Investments LLC using data presented in Morningstar

0
0 5 10 15 20 25 30 35 Software products. All rights reserved. Used with permission. Past performance is not a
STANDARD DEVIATION (%) guarantee or reliable indicator of future results.

In a similar fashion, by moving just 10% from the equity

Exhibit 6 Risk/Reward (1/1999–9/2013) allocation of a typical 60/40 portfolio to commodities and
6.0
real estate, overall portfolio returns were enhanced while
overall risk was simultaneously reduced.
5.5

100% Stocks
AVERAGE ANNUAL RETURN (%)

5.0

60% Stocks / 40% Bonds

50% Stocks / 40% Bonds / 5% Real Estate / 5% Commodities
4.5

Source: Morningstar. The statistics stated above and the accompanying tables are
4.0 derived from Morningstar Direct and Barclays. Calculated by Prudential Investments
using data presented in Morningstar. All rights reserved. Used with permission. As of
9/30/2013. Annualized returns and standard deviation for risk/return are based on indexes.
3.5 Allocations are rebalanced annually. Stocks are represented by the S&P 500 Index. Bonds
are represented by the Barclays U.S. Aggregate Bond Index. Real estate securities are
represented by the equal portions of the FTSE NAREIT All Equity REITs Index and the NCREIF
3.0 Property Index. Commodities are represented by the S&P Goldman Sachs Commodity Index.
0 5 10 15 20 25 30
STANDARD DEVIATION (%)
Index performance is not representative of the performance of a specific security. An
investment cannot be made directly in an index.
11
 Common volatility concerns associated with both REITs and equity strategies may be mitigated by incorporating a
private real estate component to the asset mix, as in the Day One Fund suite. Private real estate has historically had
a significantly lower correlation to stocks and bonds than public real estate, thus increasing its potential portfolio
diversification benefits and potentially improving risk and return characteristics.

Exhibit 7 The Value of Private Real Estate

1.0

0.8

Historical
Correlation: 0.61
0.6
1999–2013

• Public Real Estate 0.4

• Private Real Estate

0.14 0.2

0.0

–0.02
–0.16 –0.2

CORRELATION TO U.S. STOCKS CORRELATION TO U.S. BONDS

Note: Correlation refers to the relationship between two variables, in this case private real estate to equities (represented by the S&P 500 Index) and bonds (represented
by Barclays U.S. Aggregate Bond Index). Correlations can vary from +1 to –1, with +1 representing a high degree of positive correlation, and –1 a high degree of negative
(opposite) correlation. Indexes are not available for direct investment.
Source: As of December 31, 2013. Public real estate is represented by the FTSE NAREIT All Equity REITS Index. Private real estate is represented by the NCREIF Property Index.

Employing both active and passive strategies

At Prudential, we adhere to the strong fundamental belief
that active management adds value. Target-date funds that
Risk-Controlled
are structured to passively track an index do so with the Active Equity Fundamental
Large Cap Active Equity
opportunity cost of missing out on the potential upside that Mid Cap Small Cap
Emerging Markets
skilled active management can provide. Conversely, TDFs
that rely exclusively on active management may assume a
higher degree of manager risk by exposing participants to Passive
potentially greater security selection risk. S&P 1500 Index
Russell Developed
Ex-North America
As a result, we’ve opted to combine both active and passive Large Cap Index

strategies within our Day One Fund suite in an effort to

capture some degree of upside potential while attempting
Fixed
to constrain volatility and deliver a more cost-effective Non-Traditional Income
investment mix for participants. In addition, the Day One Real Estate
Commodities
Core Bond
TIPS
Fund suite utilizes several active but risk-controlled equity Short-Term Bond

strategies in an effort to further reduce portfolio volatility.

12
Modifying behavior to overcome accumulation/withdrawal challenges
Recent studies—such as a 2013 Pensions and Retirement Security study by the National Institute on Retirement
Security—continue to warn of sizeable retirement shortfalls on the horizon, with little traction being gained in motivating
participants to save more. According to the NIRS study, “The road to retirement has deteriorated dramatically...
and Americans just aren’t saving enough in their individual accounts. The situation has grown more dire with the
‘double whammy’ of the global financial crisis and Baby Boomers reaching retirement age with inadequate retirement
income.”12

Thanks to the behavioral finance work of a new generation of psychologists and economists, though, we’re now better
able to understand and overcome some of the key psychological hurdles that lead plan participants to delay financial
decisions, or worse, make bad ones.

Inertia, for example, is a very real threat. Left to their own devices, those who are
either not participating or participating at low deferral rates will typically tend to
One means of addressing
value their current state (higher take-home pay) more than a future state that can
potentially result in greater retirement savings. That preference for the status quo
inertia is by using
is reinforced by a strong “present bias” for short-term benefits over long-term automatic features
rewards. In fact, numerous studies have shown that offered the choice between such as auto-enrollment
$50 now and $100 a year from now, most participants would choose the smaller and qualified default
immediate benefit (a tendency known as hyperbolic discounting). investment alternatives
(QDIAs). The Prudential
There is also a natural tendency for the newly retired to significantly overspend. Day One Funds and Day
Retirement is a big lifestyle change and the freedom associated with it can be
One IncomeFlex Target
very expensive. Despite a sea of financial advisors counseling retirees to strive
Funds can both be used
for a sustained 3.5%–4% annual withdrawal rate, we found that when it came
time to retire, those participants not invested in an in-plan guaranteed retirement
as QDIAs.
income option (such as IncomeFlex Target) actually withdrew an average of 7%
to 15% of their market value from their plan each year.13

At Prudential, we believe that the industry needs to engage plan participants differently—to communicate with them
in ways that will not only resonate but will trigger behaviors that overcome negative tendencies. Since more than one
third of pre-retirees expect to draw the majority of their retirement income from employer-sponsored plans,14 we try
to give plan sponsors the tools they need to educate employees and help them reach their Day One of retirement
with confidence. The extensive behavioral research we’ve conducted into longevity, procrastination, and emotional
decision-making has, we believe, not only allowed us to design a more comprehensive target-date fund suite, but to
communicate with and educate participants in a more compelling manner.

These critical insights have led us to develop a host of mission-critical participant education tools including our Bring
Your Challenges website (bringyourchallenges.com), featuring the Prudential Challenge Lab, as well as our Prepare with
Pru planning solutions website (preparewithpru.com) and our Experience Day One Funds site (experiencedayonefunds.
com), all of which have helped to create a stronger, more visceral, and emotional connection between plan participants
and their Day One of retirement and beyond.

12
National Institute on Retirement Security, “Pensions & Retirement Security: A Roadmap for Policy Makers,” 2013.
13
Prudential Retirement Book of Business, 2011.
14
Prudential Retirement, Financial Literacy and Retirement Readiness Study, 2014. 13
 The Prudential Challenge Lab explores five key challenges that participants face in planning for retirement:

Challenge 1 Challenge 2 Challenge 3 Challenge 4 Challenge 5

I might live I’ll do it It won’t happen I just can’t I want it
how long? later to me resist now

These behaviors and thought patterns get in the way of people’s planning for their future, which is why the Day One
Fund suite tries to address and solve for them by setting and following glidepaths that take into account factors like
longevity and long-range goal planning.

Other common scenarios also get in the way of sound planning. Our Fuzzy Logic
video specifically explores the effect on decision-making (namely, inertia) when we To watch the Fuzzy Logic
are faced with too many choices. It’s an entertaining and informative look at the video or view a time-traveling
way in which too many choices, complexity, and uncertainty can create emotional retirement journey, visit
overload and hinder participants’ ability to make good decisions—especially in dayonefunds.com
regard to retirement income planning.

Another innovative participant tool is the Experience Day One Funds website. Using plain-English, eye-catching
graphics, and the latest Internet animation capabilities, this site takes participants on a journey where they can:

•• Understand how life changes and milestones can have an impact on their retirement plans, and the actions they
might consider
•• Learn about important considerations in relation to investment choices
•• Get insights on some of the ways target-date funds can be a useful part of a retirement-savings strategy
•• Realize that small, actionable steps may be all they need to get on the right path

Conclusion
Our intention for this paper is to create a better understanding of the research and philosophy underpinning our suite
of Day One target-date funds, especially the design of the glidepaths. As you have seen, our primary drivers were the
need to design target-date funds that address the retirement risks that all people face—investment risk, inflation risk,
sequence of returns risk, and longevity risk—with a particular focus on reducing, or even eliminating, longevity risk. We
hope this paper has helped explain the thought process behind the construction of Prudential’s Day One Fund suite
and how it helps to address the emotional and analytical aspects of saving and investing.

Based on our 85 years of experience working with thousands of retirement plans, millions of plan participants, and
leading investment managers and behavioral experts, our Day One Fund suite is a reflection of our belief that we at
Prudential have the insight and commitment to help participants reach their Day One of retirement with confidence.

14
Investors should carefully consider a fund’s investment objectives, risks, charges, and expenses before investing.

As with all investments, there are a number of factors and risks to consider in selecting a target date fund. In addition to anticipated
retirement date, relevant factors for Fund selection may include age, risk tolerance, other investments owned, and planned withdrawals.
In addition, participants should carefully consider the investment objectives, risks, charges, and expenses of any Fund before investing.
It is possible to lose money in a Fund—including near or following retirement—and there is no guarantee that the Funds will provide
adequate retirement income. Investments in the Funds are not deposits or obligations of any bank and are not insured or guaranteed by any
governmental agency or instrumentality.

Prudential Day One Funds are offered in the following structures: (i) insurance company separate accounts available under group variable
annuity contracts issued by Prudential Retirement Insurance and Annuity Company (PRIAC), Hartford, CT, a Prudential Financial company,
and (ii) collective investment trust funds established by Prudential Trust Company, as trustee, a Pennsylvania Banking Corporation
located in Scranton, PA, and a Prudential Financial company. Each of PRIAC and Prudential Trust Company is solely responsible for its
own contractual obligations and financial condition. Offers of the collective trust funds may only be made by sales officers of Prudential
Trust Company. PRIAC and Prudential Trust Company have each engaged Quantitative Management Associates LLC, an SEC registered
investment adviser and a Prudential Financial company, to perform asset allocation and certain other services.

The Day One Funds, as insurance company separate accounts or collective investment trusts, are investment vehicles available only to
qualified retirement plans, such as 401(k) plans and government plans, and their participants. Unlike mutual funds, the Day One Funds
are exempt from Securities and Exchange Commission registration under both the Securities Act of 1933 and the Investment Company Act
of 1940, but are subject to oversight by state banking or insurance regulators, as applicable. Therefore, investors are generally not entitled
to the protections of the federal securities laws.

The Prudential Day One IncomeFlex Target Funds were designed for use with Prudential IncomeFlex Target, an in-plan guaranteed
retirement income product, and are available as insurance company separate accounts under group variable annuity contracts issued by
Prudential Retirement Insurance and Annuity Company (PRIAC), Hartford, CT. PRIAC does not guarantee the investment performance
or return on contributions to those separate accounts. Availability and terms may vary by jurisdiction, subject to regulatory approvals.
Guarantees are based on claims-paying ability of the insurance company and are subject to certain limitations, terms, and conditions.
For more information, participants should access the participant service center or call 1-877-778-2100 for a copy of the Prudential
IncomeFlex Target Important Considerations before investing. PRIAC is a Prudential Financial company. Annuity contracts contain
exclusions, limitations, reductions of benefits, and terms for keeping them in force.
Contract form #GA-2020-TGWB4-0805 or state variations thereof.
280 Trumbull Street
Hartford, CT 06103

prudential.com

For more information contact your Prudential representative or the contributing authors:

Michael Rosenberg Kurt Mansfield

Senior Vice President, IODC Vice President, Product Marketing
Prudential Investments Prudential Retirement
973.367.5430 860.534.2185
michael.rosenberg@prudential.com kurt.mansfield@prudential.com

Scott Boyd Julia Salnikova

Vice President, Strategic Relationships Director, Investment Marketing
Prudential Retirement Prudential Retirement
860.534.2330 860.534.2100
scott.boyd@prudential.com julia.salnikova@prudential.com

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