The PBS program Frontline recently aired a documentary called "The Retirement Gamble" that cast the entire financial services industry in a negative light, leveling especially harsh criticism at 401(k) plans and mutual fund fees. Were the criticisms warranted? And more importantly, what can retirement savers do to put the odds of success in their favor?

There is a retirement problem

The documentary opened with this statement: "Let's begin with one simple fact: America is facing a retirement crisis." Host Martin Smith noted, "Half of all Americans say they can't afford to save for retirement. One-third has next to no retirement savings at all."

No argument there — at least not with the program's description of the retirement landscape. It is consistent with the findings of other surveys, which show large numbers of Americans to be woefully under-prepared for retirement.

The blame game

The program largely blamed poor retirement preparedness on the shift away from defined-benefit plans (pensions), the move toward what it described as overly complex defined-contribution plans (401(k)s), and far too many investment-related fees.

The piece waxed nostalgic for a simpler time when defined-benefit pensions were common. "Workers didn't have to figure out how to manage their own savings; it was done for them," Smith said.

However, even he pointed out that just 42% of employees had such a pension in 1970, and even that figure may be overstated. According to the Employee Benefit Research Institute, only 25% of those age 65 or older had pension income in 1975.

No matter what was true back then, what's true today is that the workplace retirement plan of choice is the 401(k). Introduced in the late 1970s, such plans leave it up to employees to make three crucial choices: how much to save, what to invest in, and how to withdraw money during retirement.

According to the documentary, that's asking too much of the average worker. One 401(k) plan participant told interviewers, "It was overwhelming for me — the knowledge that you had to have in order to invest." Another complained, "There was nobody there managing my money. It was all up to me."

Robert Hiltonsmith figured prominently in "The Retirement Gamble." At first, he was depicted as just another struggling 401(k) participant. "I have a 401(k)," he said. "I save in it. It hasn't seemed to go up. It's awful. I kept checking the statement. I'd be like, 'Why does this thing never go up? This is weird.'"

Hiltonsmith turned out to be a young economist working at Demos, a New York City think tank. Confusion over his own company's 401(k) led him to take a closer look at the plan, which turned into a research paper about the retirement industry that was published in 2012. Reading the prospectuses of each fund in his company's plan, Hiltonsmith found it difficult to understand what the various funds invested in. And he noticed a surprising number of fees, many of which, he felt, were not clearly disclosed: "Why would you think 'Exp. Ratio' means fees?...It was very opaque."

He counted over a dozen fees — asset management fees, trading fees, marketing fees, record keeping fees, administrative fees, and more. Over the course of a career, Hiltonsmith estimated, the average plan participant would pay more than $155,000 in fees. "That's the difference between running out of money before you die or having a little money to pass on to your heirs," said a financial journalist interviewed for the program.

Putting fees under the microscope

All mutual funds have fees, just as every other type of business has costs of doing business that are passed along to its customers. Still, three points raised by the program are worth highlighting.

First, it's true that some mutual fund fees are not readily apparent. By the time an investor reads about a fund's performance, for example, the "exp. ratio" fees have already been paid to the fund company. "Exp." stands for "expense" and "ratio" means the fee is based on a percentage of a customer's balance. A fund with an expense ratio of 0.98% is charging $9.80 for every $1,000 a customer has invested in the fund to help cover its operating expenses. Some funds list a separate "12b-1 fee" used to recoup some of their marketing costs. While listed separately, those fees are already included in the overall expense ratio.

While a fund's prospectus discloses these fees, when an investor reviews his or her statement, the fees are not mentioned. Instead, they have already been subtracted from the investor's balance — and subtracted in calculating the fund's reported return. For example, a fund that delivers an 8% gross return in a given year while charging a 1.0% expense ratio would show a 7% return on its statement.

Second, mutual fund fees are not performance-based. In other words, if a fund charging a 1.0% expense ratio grows an investor's starting balance of $10,000 by 10% (a gain of $1,000), the fee is not 1% of the year's performance gain, it's 1% of the account's total balance. In other words, even if the account earns nothing for the year, you're still going to pay 1% of your total balance in fees.

Third, all else being equal, a fund charging lower fees will provide an investor with more money than a fund charging higher fees. So, investors choosing between two funds with similar strategies and performance records should choose the fund with the lower expense ratio. This is especially important for investors who hold their investments for a long time.

The chart on the left compares the results of a one-time lump sum $10,000 investment under three different scenarios. The first column shows what $10,000 would grow to (at the rate of return shown) after 10, 25, and 50 years if no fees were charged. The next column assumes a 0.5% expense ratio and the third column a 1.0% ratio. The most realistic comparison is between columns two and three since all funds charge fees. After 50 years, the difference between a 0.5% expense ratio and a 1.0% ratio amounts to more than $75,000. Clearly, fees matter.

But they matter most for people whose 401(k) or other workplace retirement plans offer a limited selection of mostly high-fee mutual funds. If that describes your plan, talk with your plan administrator to see if any changes are possible. If your plan includes index funds, those likely charge relatively low fees. After determining your proper asset allocation, you may be able to use the index funds in your plan to construct a properly diversified, low-cost portfolio. As much as the options in your plan permit, follow the suggested allocations for SMI's Just-the-Basics strategy, which is designed to match the market's performance.

SMI believes that when trying to beat the market, which is what SMI's Fund Upgrading strategy is designed to do, fees should take a backseat to performance. Within the context of this well-defined, mechanical strategy, we're willing to own a more expensive fund if it is exhibiting strong performance. Upgrading's performance-momentum calculation already factors in fees, i.e., all fees already have been subtracted from each fund's published performance. As a result, we don't emphasize funds with low expense ratios within Upgrading, as the performance-momentum calculation already rewards and penalizes funds for their fees. We do, however, use the stated expense ratio as one of several "tie-breakers" when deciding between two funds with similar momentum scores.

Raising fee awareness

The Department of Labor, which has oversight for workplace retirement plans, last fall began requiring plans to do a better job of disclosing various fees. The hope was that more-informed participants would demand lower-cost investment options and choose mutual funds with lower fees.

However, a study conducted by LIMRA, a financial services industry association, in the first quarter of 2013 found that half of 401(k) plan participants did not know how much they pay in fees. That's the same number as before the new rules took effect. Still, some changes are starting to be seen. The LIMRA study found that just 22% of participants believed they paid no fees — down from 38% before the new rules took effect.

Another idea the Department of Labor is considering is a requirement that plans provide an estimate on savers' statements showing how much income they might expect from their savings once they retire. The hope is that the information will spur people to save more. The Department has an online Lifetime Income Calculator available that anyone can use to run such estimates.

If you work for a larger employer, you may also be able to check on your plan's fees via

Other action steps

Additional cautions raised by the Frontline program:

Don't dip into your retirement savings. Keep the money there for its intended purpose: retirement. Martin Smith learned this lesson the hard way. While he started saving for his retirement in his 20s, he acknowledged tapping those savings several times over the years. Today, he is nearly 65 and has far too little saved.

Prioritize retirement savings over college savings. Again, this is a lesson Smith learned through trial and error. He said most of his savings went to pay for his kids' education expenses, although he noted that going through a divorce didn't help either.

Save more. This was actually the program's most glaring omission — no mention of how little people are saving in their workplace plans, except to imply that workers are not to blame. "Without knowing exactly how long you're going to live," Smith said, "it's difficult to guess how much you need to put away."

Robert Hiltonsmith begrudgingly acknowledged his own need to do more. "The truth is, I'm just going to have to find a way to save way more than you should have to." He pegged that amount at 10% to 15% of his salary.

Of course, none of us knows how long we will live. However, the Social Security Administration's longevity calculator, along with an honest assessment of your family's health history, should help generate a conservative estimate. That, coupled with an online retirement calculator, can be used to run the numbers on how much you're likely to need in retirement and, by extension, how much you need to save each month.


Is retirement investing a complex process? Absolutely. Are individuals capable of handling this task? We believe they are, but it doesn't just "happen." The new retirement paradigm does require effort on the part of today's employees. But it's not so difficult as to be beyond the ability of most adults, if they're willing to learn a handful of basics.

As you consider this responsibility, keep in mind the founding verse of Sound Mind Investing: "For God has not given us the spirit of fear; but of power, and of love, and of a sound mind" (2 Timothy 1:7).