Target-Date Funds vs. DIY Investing: What Works Best for You?

As a financial planner, I frequently hear this question: "Should I use a target-date fund or build my own portfolio?"

The answer isn't about which approach delivers better returns on paper. Both can work equally well from a pure performance standpoint. The real difference comes down to investor behavior, taxes, and your specific financial situation.

Let me walk you through what the research shows and help you determine which approach fits your needs.

What Are Target-Date Funds?

A target-date fund (TDF) is essentially investing on autopilot. You choose a fund based on when you plan to retire—say, a 2050 fund if you're retiring around 2050—and the fund automatically:

• Maintains broad diversification across stocks and bonds
• Rebalances your portfolio regularly
• Gradually reduces risk as you approach retirement

Think of it as a "set it and forget it" solution that handles the technical details for you.

Performance: It's Basically a Tie

Here's what might surprise you: when properly executed, DIY portfolios and low-cost target-date funds deliver nearly identical long-term returns.

Research from Vanguard, Morningstar, and Fidelity consistently shows that a simple 60/40 or 70/30 portfolio of stock and bond index funds performs about the same as a comparable target-date fund—before considering investor behavior and taxes.

So if performance is roughly equal, what makes the difference?

Why Target-Date Funds Often Win in Practice

The biggest enemy of investment success isn't market volatility—it's human emotion.

The Behavior Problem Studies consistently show that the average investor significantly underperforms market returns. DALBAR's research indicates this "behavior gap" costs investors 3-4% annually due to poor timing decisions, panic selling, and chasing performance.

How Target-Date Funds Help Target-date fund investors tend to capture 85-95% of market returns, while self-directed investors often capture only 60-75%. Why? The automation removes emotion from the equation.

When markets crash, target-date funds keep rebalancing automatically. Many DIY investors, however, sell at the bottom or stop contributing altogether.

The Rebalancing Advantage Most people don't rebalance consistently. They let their portfolios drift toward more risk during bull markets and become overly conservative after market downturns. Target-date funds eliminate this problem entirely.

When Target-Date Funds Make Perfect Sense

Target-date funds excel for:

Workplace retirement savers who want simplicity and consistency. If you're contributing to a 401(k) or 403(b) and want a hands-off approach, a low-cost target-date fund is hard to beat.

Investors prone to emotional decisions who might otherwise buy high and sell low. The automation protects you from yourself.

Those in the accumulation phase who are steadily saving for retirement. The automatic risk reduction over time works well when you're building wealth.

When You Should Skip Target-Date Funds

Despite their benefits, target-date funds aren't universal solutions. Here are the key situations where a custom approach works better:

1. You're Already Retired or Very Close

Target-date funds are designed for accumulation, not distribution. Once you need to withdraw money regularly, you need more sophisticated planning.

In retirement, you want control over:

• Which accounts you tap first for tax efficiency
• Which investments you sell in down markets
• How to coordinate Social Security, pensions, and portfolio withdrawals

Target-date funds can't handle this complexity.

2. You Have Substantial Taxable Investments

Target-date funds work beautifully inside 401(k)s and IRAs where taxes don't matter. But in regular brokerage accounts, they're often tax-inefficient because:

• Bond interest gets taxed at ordinary income rates
• You can't control when capital gains are realized
• You can't harvest tax losses

For significant taxable wealth, custom portfolios that separate stocks and bonds across account types typically save thousands in taxes annually.

3. You Have Multiple Account Types

If you're managing money across traditional IRAs, Roth IRAs, 401(k)s, and taxable accounts, putting a target-date fund in each creates unnecessary redundancy and poor tax efficiency.

A coordinated approach might place:

• Growth investments in Roth accounts
• Bonds in traditional retirement accounts
• Tax-efficient stock funds in taxable accounts

Target-date funds can't orchestrate this kind of tax optimization.

4. You Have Pension Income

Standard target-date funds assume you have no guaranteed retirement income. If you're a teacher with a pension or a federal employee with FERS, you can often afford more investment risk than a target-date fund provides.

The guaranteed income acts as your "bond allocation," allowing your investment portfolio to be more growth-oriented.

Costs Matter—But Only for Some Funds

Not all target-date funds are created equal:

Low-cost index versions (like Vanguard, Fidelity, and Schwab) charge 0.06-0.15% annually—very reasonable.

Actively managed versions often charge 0.40-0.75%, which can reduce your wealth by hundreds of thousands over a career. Skip the actively managed target date funds with high expense ratios.

Always check the expense ratio. Anything above 0.20% for a target-date fund is probably too expensive.

The Bottom Line

For most people saving for retirement in workplace plans, low-cost target-date funds are excellent tools. They provide diversification, automatic rebalancing, and protection from behavioral mistakes.

But they're not optimal for everyone, particularly:

• Retirees who need income planning
• Investors with complex tax situations
• Those coordinating multiple account types
• People with pensions or other guaranteed income

The key insight from decades of research is this: the biggest threat to investment success isn't picking the "wrong" portfolio—it's making emotional decisions at the wrong time.

Target-date funds solve the emotion problem. Custom portfolios solve the optimization problem. Choose based on which problem is bigger in your situation. Reach out to me via the contact page below to learn whether target-date funds fit your retirement goals.

Disclaimer: This content is for educational purposes only and is not personalized financial advice. Investment strategies should be tailored to your individual circumstances. Past performance does not guarantee future results, and all investments carry the risk of loss. Consult with qualified financial and tax professionals before making investment decisions.