When Hillary Clinton released a financial disclosure statement on Friday, there was a lot of controversy over the long list of special interest groups that paid her speaking fees over the last 18 months. Yet there is something in Clinton's disclosures that everyone should emulate: investing in low-cost index funds.
Presidential candidates are required to report investments in ranges, and Clinton disclosed that she had invested between $5 million and $25 million in Vanguard's popular S&P 500 index fund, which invests 500 of the largest publicly-traded companies in America. She also had $5 million to $25 million in "JP Morgan Custody Account (Cash)." None of her other investments — some life insurance policies and government bonds — were worth more than $1 million.
In short, the majority of Clinton's investments (not counting the JP Morgan cash account) are in a type of low-cost mutual fund called an index fund. While most of us don't have $5 million to invest, her investment strategy is one that would benefit anyone saving for retirement.
Some mutual funds spend a lot of money doing market research to decide which stocks to invest in. In the 1960s, academic researchers started studying whether these funds produced higher returns for their investors. Surprisingly, the answer was no: the average returns for these "actively managed" funds wasn't much better than you'd get by choosing stocks with a dart board.
This research led to the rise of a new type of mutual fund known as an index fund. Rather than trying to beat the market, these passively managed funds simply buy every stock in an index such as the S&P 500. Index funds allow investors to earn the average market return. And because they don't have to hire a bunch of people to do research, they're very cheap to run. As a result, their returns after expenses tend to be higher than those of actively managed funds. A half-century later, studies are still finding that passively managed funds consistently overperform actively managed ones, once expenses are taken into account.
The key to a good index fund is something called its expense ratio. That's the fund's operating expenses divided by its total assets. The lower this number is, the less of your earnings will be siphoned away to pay the company managing the fund. Vanguard, which was founded on the index fund concept back in the 1970s, still offers some of the cheapest funds in the industry. If you have at least $10,000 to invest, Vanguard has an S&P 500 index fund with an expense ratio of just 0.05 percent — that's a cost of just $5 per year for every $10,000 you invest. Conventional, actively managed mutual funds tend to have expenses that are 5 to 20 times higher.
Vanguard isn't the only company with affordable index funds. Fidelity's Spartan funds are about as cheap as Vanguard's. And State Street and Vanguard both offer slightly more expensive target retirement funds that help customers hold an age-appropriate portfolio of investments while charging less than 0.20 percent. You can read all the details about choosing a good mutual fund here, and I have a more comprehensive guide to saving for retirement here.
Disclosure: I have most of my retirement savings in Vanguard mutual funds, and because Vanguard is structured as a cooperative, that technically makes me a Vanguard shareholder.
Correction: The S&P 500 contains 500 large American companies, but not necessarily the 500 largest as this article originally claimed.