Target-date funds are designed to solve the problem of asset allocation, giving time-strapped investors an effortless way to diversify their funds. And, to some extent, they succeed in that mission. Certainly, investing in target-date funds is better than doing nothing (or, worse, betting it all on gold).

But there's a cost to that diversification -- and it might be more than you can bear. Here are three big issues with target-date funds.

Three yellow triangles, one with a white exclamation point, and two with black exclamation points in them.

Image source: Getty Images.

1. Not all retirements are the same

Target-date funds are supposed to be set-it-and-forget-it funds for the average person. Only problem with that is: Most people aren't average. You may have a more aggressive mindset when it comes to investing, so you're willing to accept greater risk than the target-date fund accounts for. Consider the example of someone who retires at 65 but has a strong family history of longevity -- their retirement time horizon is enormously different from another 65-year-old suffering from poor health. Target-date funds don't account for these differences.

Retirements also look different from the money side. Believe it or not, about 32% of retirees receive income from pensions (and there are still companies -- like big pharma Roche -- that offer pensions to new employees). The rest of us have to rely on (primarily) self-funded accounts like 401(k)s, 403(b)s, and IRAs. Some retirees have annuities -- others, reverse mortgages. (Still others, student loan debt.) The point is, target-date funds by nature aren't set up to properly serve all the little nuances of your particular situation. Only you (or someone you pay to do it for you) can do that. Of course, that requires the time (or money to pay for someone else's time) to get all those nuances right.

2. Fees, fees, fees

Target-date funds are actively managed -- someone has to decide how to change those fund allocations over time. Consequently, they charge annual expense ratios significantly higher than index funds (0.51% vs 0.09% on average, according to the Investment Company Institute ). That extra 0.42% may not sound like a lot, but it works out to quite a lot over the length of a career.

As an example, let's say that you have nothing saved in investments today, but you put away $5,500 a year for the next 30 years. Your funds earn 7% annually above inflation before fees (around the stock market's historical average). In the index fund scenario (that is, a 0.09% expense ratio), you end with just over $511,000. If you pay that higher 0.51% expense ratio then, all other things being equal, you'll have a little over $474,000 in savings instead -- a loss of about $37,000 because of those extra fees.

That's a big chunk of change to pay out. And I don't think it's worth it.

3. Too conservative?

This last point is more a matter of opinion than anything else because, as I noted in issue No. 1, all retirements are different. But I think they're generally too conservative in their asset allocation. Even funds targeted at relatively young investors hold bonds -- which I think unnecessarily reduces our ability to grow our portfolios, particularly in a low-interest rate environment in which bond yields are terrible.

To better display all of this, I figured I'd use me as an example. I was born in 1989, so theoretically my retirement date (if I retire at 65) is 2054 -- here are some of the major 2055 target-date funds:

Fund  Gross Expense Ratio Percent Held in Bonds
Fidelity Freedom 2055 Fund 0.75% 6.21%
T. Rowe Price Retirement 2055 Fund 0.74% 11.30%
BlackRock LifePath Index 2055 Fund (A Shares) 0.59% 1.23%
Vanguard Target Retirement 2055 Fund 0.15% 10.07%

Source: Fund sites.

To be honest, I think that any amount of bonds is too much for a 29-year-old...right now, the best way we can invest for retirement is to swing for the fences. Yet among these four funds (which, to be clear, I picked because they were offered by recognized names), two already have bonds representing a double-digit percentage of holdings!

(And don't get me started on the fees they're charging -- only Vanguard's fee is reasonable.)

There's a better way to do this

Asset allocation may seem like an imposing problem to try to solve, but you can get most of the way there pretty easily. One way I personally like is to take a target-date fund, see its exposure to different asset classes (aside from bonds if you're young), and seek to get reasonably close to mirroring them. Let's take a simple example: The Vanguard Target Retirement 2055 Fund is allocated across four funds: 

Fund

Allocation

Vanguard Total Stock Market Index Fund Investor Shares

53.7%

Vanguard Total International Stock Index Fund Investor Shares

36.2%

Vanguard Total Bond Market II Index Fund Investor Shares

7.1%

Vanguard Total International Bond Index Fund Investor Shares

3%

Source: Vanguard.

It's not hard to duplicate those allocations and reweight the two stock index funds to account for removing the 10.1% bond allocation. Now, since Vanguard's fees are so low across the board, you don't save any money in fees here -- the Vanguard total stock market fund sports a 0.14% expense ratio, while the international fund charges 0.17% -- but at least you get to make the allocation fit your personal preferences.

This gets more difficult with the other funds I highlighted, since they're diversified across more stock funds (often with higher expense ratios), but in most cases, you should be able to find Vanguard funds that are very similar -- and way cheaper.

Target-date funds give you a great place to get started on the complicated problem of asset allocation, but you can take that information and apply it without accepting their (generally) too-high fees. Plus, tailoring things to your own preferences gives you a better opportunity to seize control of your financial future. And, really, that's what we're all looking for anyway.

Michael Douglass has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.