About 40 million Americans have invested in target-date funds (TDFs), those ready-made, all-weather portfolios of stock and bond funds that automatically grow more conservative as you age toward a specific retirement date. TDFs have attracted more than $1.7 trillion in assets because they are simple to use, offer wide diversification in tumultuous times and provide solid returns even if you have no interest or expertise in managing your nest egg.

But top financial educator Paul ­Merriman thinks you can do better—with just a little effort. He says you can replicate your own version of a TDF using low-cost exchange-traded funds (ETFs) and reap several benefits, including saving tens of thousands of dollars in fees…customizing your fund to improve performance…and tailoring it to your own personal time horizon and risk tolerance.

Below, Merriman shares with ­Bottom Line Personal readers the hidden drawbacks of conventional TDFs…and he provides a step-by-step guide to building your own TDF.


Conventional TDFs have been around for more than 25 years, but investors still are in the dark about how much they cost and their risks and shortcomings. Here’s why I think they are not the best solution for many small investors…

TDF fees often are too high. Conventional TDFs charge an average annual expense ratio of 0.55%, or $550 per $100,000 investment. Many fund families use in-house actively managed funds that drive up costs, such as ­Capital Group’s American funds (annual expense ratios range from 0.61% to 0.81%)…Fidelity’s Freedom funds (from 0.49% to 0.75%)…and T. Rowe Price (0.34% to 0.64%). By contrast, you could construct a do-it-yourself (DIY) TDF with an expense ratio of just 0.09%, or $90 per $100,000.

They are too generic. Conventional TDFs cater to millions of investors so they’re forced to take a one-size-fits-all approach, and that may not align with your individual needs. Example: Most TDFs are offered in five-year intervals, and each fund family has a proprietary “glide path”—the rate at which portfolio allocations grow less risky, gradually shifting from stocks to bonds as you age. So if you plan to retire in 2027, you would have to use a 2025 fund or a 2030 fund, neither of which may be right for you.

They are too conservative. Most TDFs keep a minimum of 10% of their portfolios in bond funds. This reduces volatility but hurts young investors who have decades to go before retirement by creating an unnecessary drag on long-term performance. Also, many conventional TDFs drop their stock exposure too much during your working years so that you end up with a 50% stock–50% bond allocation at age 65. While your portfolio should grow less daring as you get closer to needing the money, a 50%–50% allocation may not provide enough growth to make your money last another 30 years once you stop working.

They rebalance too frequently. Many TDFs buy or sell stocks and bonds on a regular basis in order to maintain their desired asset allocation. Frequent rebalancing lowers the short-term volatility of your portfolio and keeps it targeted to the appropriate level of risk—but it also curtails positive momentum and decreases long-term performance.

Three Steps to Build Your Own TDF

You can correct many of the shortcomings of conventional TDFs by putting together and managing one on your own. This may sound intimidating, but it’s relatively easy to set up and, once established, takes little annual oversight. Note: I typically recommend DIY TDFs for IRAs because they offer a variety of investments. However, it may be possible to build one in a 401(k) account, too, using mutual funds.

Step #1: Decide on your asset-class allocation. Until age 40, you are best-served by having a 100% stock allocation in your portfolio and no bonds. This maximizes your returns, and you will have plenty of time to recover from any bear markets. Depending on your situation, split the stock portion of the portfolio by putting 50% in a total US stock market ETF and 50% in a total international stock market ETF.

If you are a moderate or aggressive investor, put one-third of your portfolio in both the total US and international ETFs and the remaining one-third in a small-cap value ETF. Why own small, undervalued companies? Because they have the best long-term performance records of any stock asset class. In the past century, small-cap value stocks have returned approximately an annualized 13% versus 10% for large-cap stocks.

Once you are over age 40, begin adding a fixed-income component to your portfolio to tone down volatility. Split your fixed-income allocation among three different types of bonds in the following proportions—an intermediate-term bond ETF (50%)…a short-term bond ETF (30%)…and an inflation-protected government bond ETF (20%).

Example: Using these guidelines, here is what a portfolio allocation would look like for a moderate investor at age 55…

Step #2: Choose your glide path from age 40 to 65. I recommend that a moderate investor shift 8% of his/her stock allocation into bonds every five years. If you start with a 100% stock allocation at age 40, you would have 60% in stocks and 40% in bonds by age 65. A more aggressive investor could shift 6%, which produces a 70% stock/30% bond allocation at retirement age. A very conservative investor should raise bond allocations and lower stock allocations by 10% every five years, leading to a 50% stock/50% bond makeup at age 65.

Step #3: Choose the actual investments for your TDF. Here are the six allocation categories I use and a variety of low-cost funds I like in each category…

Total US Stock Market: Avantis US Equity ETF (AVUS)…iShares Core S&P 500 (IVV)…Vanguard Total Stock Market ETF (VTI).

Total International Stock Market: Avantis International Equity ETF (AVDE)…SPDR Developed World ex-US ETF (SPDW)…Vanguard Total International Stock ETF (VXUS).

US Small-Cap Value: Avantis US Small Cap Value ETF (AVUV)…SPDR S&P 600 Small Cap Value ETF (SLYV)…Vanguard S&P 600 Small-Cap Value ETF (VIOV).

Intermediate-Term Government Bonds: iShares 7-10 Year Treasury Bond ETF (IEF)…SPDR Portfolio Intermediate Term Treasury ETF (SPTI)… Vanguard Intermediate-Term Treasury ETF (VGIT).

Short-Term Government Bonds: iShares 1-3 Year Treasury Bond ETF (SHY)…Schwab Short-Term US Treasury ETF (SCHO)…Vanguard Short-Term Treasury ETF (VGSH).

Inflation-Protected Government Bonds: iShares 0-5 Year TIPS Bond ETF (STIP)…Schwab US TIPS ETF (SCHP)…Vanguard Short-Term ­Inflation-Protected Securities ETF (VTIP).

Get The Most Out of Your DIY TDF…

Rebalance no more than once a year—once every 18 months is even better. In addition to making glide path changes to your stock-bond allocations every five years, rejigger holdings back to your current allocation over shorter time periods. In a conventional ETF, you have little control over when your manager rebalances, but you can set your own schedule with a DIY fund. While less frequent rebalancing will raise your portfolio’s short-term volatility, it tends to raise long-term performance also.

Be realistic about how much investment discipline you have. By far, the greatest challenge of a DIY TDF is sticking to your investment plan consistently year after year. That’s relatively easy to do when you own a conventional TDF because you can’t fiddle with the fund’s underlying ETFs. The danger of a DIY fund is thinking that you are smarter than the market or panicking in down markets and making shortsighted moves that hurt your long-term performance. If you don’t think you can stick with it, you are better off owning a conventional TDF from a low-cost provider such as Charles Schwab or Vanguard.

Get help from a financial advisor when you reach age 65 (or retire). TDFs are designed to deliver you to your desired retirement age. But finding a suitable asset allocation for your portfolio in retirement is a lot trickier and more individualized. You need to limit portfolio ups and downs because you now are drawing money from it—but you also need to generate enough growth to make your nest egg last another 30 years.

Related Articles