From time to time I get emails or comments from people who have moral qualms with index funds–the issue being that the investor doesn’t want to own shares of companies that do things to which he/she is ethically opposed.
First of all, let’s be clear on one thing: Buying shares in a company does not really help the company itself. In almost every case, you’re buying shares from another investor. The company isn’t even involved in the transaction.
(One could argue that buying shares drives up the price, which helps the company, but that’s quite a stretch. For most of us, even if we invested our entire net worth in one company, the share price would hardly budge. Investing in index funds will have no impact upon the price of a given company’s shares.)
That said, if the issue isn’t so much that you don’t want to help the company by buying shares, but simply that you can’t justify owning shares of companies that do things you find morally reprehensible, then fine. That, at least, makes sense.
So if that’s your viewpoint, how should you go about investing?
Socially Responsible Mutual Funds
There’s an entire industry built around offering mutual funds that only invest in companies that fit certain criteria (some are religious-based, some are environmental, some screen out certain industries, etc.). It’s a neat idea.
But there’s one big problem.
The expense ratios are nothing short of appalling. Take a look. 2% annual expenses with a 5% sales load? Yuck!
Constructing a Low-Cost, Socially Responsible Portfolio
There are, at least, some low-cost, socially responsible investment options. Unfortunately, they’re few and far between, and constructing a properly diversified portfolio is rather difficult. That said, I think the main building blocks would be as follows:
In the domestic stock category: Vanguard’s FTSE Social Index Fund carries a relatively modest 0.31% ER.
Fixed income: This part is easy–simply avoid corporate bond funds completely and invest exclusively in low-cost Treasury-bond funds. (Many experts recommend doing this anyway, for purposes entirely separate from moral considerations.)
International stocks: This part of the portfolio is trickiest, as I can’t find a single option that I’d really be happy investing in. My pick at this point would be Domini European PacAsia Social Equity Fund. (Portfolio turnover 31%, expense ratio 1.60%–far too high for my tastes, but modest among socially responsible funds.)
Additional Concerns
The Vanguard index fund is a large-cap growth fund. So an investor may want to include a domestic large-cap value fund and/or a domestic small/mid-cap fund as well.
Essentially, you have to perform a balancing act. On the one hand, you can lower your costs by over-weighting the Vanguard fund (the domestic, large-cap growth portion of your portfolio). Or, you can benefit from additional diversification (at the cost of higher expenses) by increasing the allocation to other equity classes–whether international stocks, small/mid-cap domestic stocks, or domestic value stocks.
Also, the above portfolio necessitates having accounts with at least 2 brokerage firms (Vanguard and Domini Social Investments). Vanguard has no account fees, and as far as I can tell, neither does Domini, but having multiple accounts is still a bit of a pain.
Finally, the published expense ratio on the Domini fund takes into account a waiver of fees–something that always concerns me. (More on this topic tomorrow. 
)
What do you think? If you were going to construct a “socially responsible” portfolio, would it look similar to the one above?
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{ 8 comments… read them below or add one }
A socially responsible fund that I really like and have recommended to clients is Neuberger Berman Socially Responsible Fund (NBSRX). It is also a socially responsible large growth fund, with an acceptable expense ratio (.89%). The major difference is that it has a 4 star Morningstar rating, as compared to Vanguard’s 1 star.
First, I can’t stand the term “socially responsible investing.” When push comes to shove, many don’t agree on what’s responsible and what’s not. And if you disagree with some or all of someone else’s perspective, are you “socially irresponsible?”
I much prefer “socially conscious investing.” I implies some thought went into the social impacts of investment choices with out claiming to be responsible versus someone else’s choices.
Also, I’ve yet to find a fund that accurately reflects my social conscience. They all seem to want to put you in a neatly labeled box with thousands of other “like” minds.
Personally, I think buying the whole market with low-cost index funds is socially conscious investing for me. I can take some of the money I save in fees and use it to support the specific causes I care most about.
Leah: Thanks for stopping by to contribute your thoughts. I took a look at NBSRX. One other noteworthy difference is that it appears to have a significant portion of its assets invested internationally (19.7% at the moment).
Dylan: My thoughts are similar. For me, I’m perfectly comfortable with any moral implications involved in owning index funds that (together) represent the entire world economy (or as close as I can manage).
That said, I understand that other people are not. In which case I figure that we might as well do our best to help those investors invest successfully within the constraints that they’ve set.
Mike and Dylan,
I agree with your thoughts here. Far too much emphasis is put on socially responsible (or conscious) investing, especially in religious circles. People think they’re going to make a difference by investing this way. Sure it shows what you support and don’t support, but it has very little real impact on the world.
If you want to see real changes or have a real influence, then donate your money or your time instead. By actually doing the good things you’d like to see in the world, you’ll make real changes – not just changes in your portfolio that make you feel better about yourself…
Paul: I think you just conveyed my thoughts on the matter better than I ever have.
I also subscribe to the school of thought that buying shares in a company does not really help the company itself. If only socially irresponsible shareholders own the company, the company may become even more socially irresponsible. Therefore I have not paid any attention to the SRI offerings. That said, the turnover ratio of the Domini fund must be 31%, not 0.31%.
“That said, the turnover ratio of the Domini fund must be 31%, not 0.31%.”
Oops! A typo indeed. Thanks for pointing that out. The post has been updated.
Mike,
I wrote an article about the problems with socially responsible or faith-based investing as I see them over at Provident Planning. I’d be interested in your thoughts. Here’s the link:
http://www.providentplan.com/298/faith-based-or-socially-responsible-investing-delusions-of-righteousness/