In conjunction with present-day debates about pressing issues like climate change, unfair labor practices, green energy, and skyrocketing obesity rates, investors are becoming more aware of the roles their money could play in perpetuating societal ills. This has led to the rapid expansion of socially responsible investing (SRI). SRI allows investors to exclude certain types of companies or industries from their investment portfolios based on their own moral values.
This sounds like a great idea…in theory. In practice, SRI is much more complicated, and focusing primarily on socially conscientious investments could potentially limit your success in the stock market. While SRI may be beneficial for our global society, it may not be the best strategy for your individual portfolio.
If you want to get off the sidelines and invest in a better future for everyone, beware the following downsides you might encounter when you’re first starting out.
Socially Responsible Investing May Not Be Great for Your Investment Returns
Limiting Your Options
There are many different types of investments deemed immoral, unethical, or outright “evil” under the umbrella of SRI. Those include: tobacco, alcohol, casinos, guns, defense contractors, fossil fuels, countries ruled by authoritarian regimes, racehorses, and pharmaceuticals, to name a few. The problem with SRI is that there’s no clear standard for what is ethical or moral because it depends on individual investors’ values.
For example, one investor may have no problem with pharmaceuticals, but strongly dislikes the idea of investing in firearms companies. Meanwhile, another investor may be a pro-gun advocate who doesn’t care much about renewable energy but wants to avoid investing in companies that manufacture drugs used in abortion procedures.
Unfortunately, there aren’t many opportunities to personalize your portfolio to this extent (if you’re investing in mutual funds), which means you’re likely limited to what fund managers deem socially conscious.
Another problem with SRI index funds is that they tend to charge higher management fees than traditional index funds. In fact, some SRI funds charge as much as 2%, while the average actively managed fund charges about 0.75%. This makes investing in socially responsible companies considerably more challenging, especially for new investors who don’t have much money upfront.
Although low-cost options like the Vanguard Group’s Social Index Fund (0.20%) and iShares MSCI USA ESG Select ETF (0.50%) exist, this further limits your options when it comes to SRI funds because you need to find one that aligns with your values and doesn’t charge an arm and a leg to manage your investments.
If you want to look for investments with low or even zero fees and commissions, check out trading on platforms like M1 Finance . You can even find specific pre-built investment pies with socially responsible companies you may like.
Missing Out on Top Performers
Companies like Apple, Amazon, and Walmart are routinely excluded from SRI funds due to controversies about their labor practices both in the U.S. and overseas. Unfortunately, this means you could be missing out on some stocks that are producing excellent gains.
This links back to the ongoing problem of SRI. There are vague guidelines for what is or isn’t “socially responsible.”
Find Other Ways to Be Socially Conscious
There’s nothing wrong with wanting to support environmentally-friendly business practices, fair wage policies, and the improvement of public health. When it comes to your investment portfolio however, social conscientiousness is not the main goal. Earning great returns on your investments should be the priority.
With this in mind, you should seek out other ways to support the things you value, whether that involves political advocacy, charitable giving efforts, volunteering, or ethical consumerism. There are plenty of ways to promote social good without sacrificing your financial future.
Alternatively, you could allocate some money towards SRI funds with low fees and solid historical performances, such as the Vanguard FTSE Social Index Fund Investor Shares (VFTSX) or the Parnassus Fund (PARNX). This type of socially conscious investing is similar to the “weekday vegetarian” trend, in which people are becoming more conscientious about the negative impacts of meat consumption but don’t want to completely cut meat out of their diets. In both cases, incremental change works best for both an individual’s personal needs and their desire to help out the greater good without having to choose one over the other.
Ultimately, it’s up to you to decide if SRI funds are good fits for your portfolio. Just make sure you review the fees, holdings, and historical performance of the fund before jumping on the bandwagon in order to avoid the gimmicky marketing tactics swirling around “socially conscious” investing these days.