Tom Nowak, CFP, an hourly financial advisor associated with the Garrett Planning Network, recently sent me a copy of his self-published book, Low Fee Socially Responsible Investing. Tom, like me, is a big fan of low-fee investing. He knows that in investing, you get what you DON'T pay for. He also, unlike me, has an interest in socially responsible investing (SRI). I told him when he offered me a free copy of the book that I didn't have much interest in SRI as I thought costs were too high and returns were too low. He said that perhaps the book would change my mind. It didn't, but I do realize that lots of people do have an interest in SRI, so I write this review for their benefit.
What's Responsible Anyway?
Tom has a lot of clients interested in investing in a socially responsible way. One of my criticisms with SRI is that one man's “socially responsible company” is another man's “socially irresponsible company.” Consider a gun manufacturer, for instance. A strong second amendment rights supporter would probably buy shares of all the gun companies. A gun control proponent might prefer to avoid investments like that. There are dozens of categories-climate change, clean technology, pollution, environment, diversity, human rights, labor relations, executive pay, alcohol, animal testing, defense/weapons, gambling, tobacco, corporate political transparency, corporate non-partisanship etc. It all depends on your worldview. If your worldview happens to coincide with that of a SRI mutual fund manager, you're in luck. You just buy that fund. If not, you're stuck with the unappealing (to me) prospect of investing in individual stocks.
SRI Is Relatively High Cost
Tom found that he had a hard time mixing these two investing principles- low-fee and SRI. Even if you choose to buy an SRI Index fund such as DSI or KLD from Ishares, you're looking at an ER of 0.50%. Even the Vanguard index fund is 0.29%. Those pale in comparison to a Total Stock Market Index Fund available from several companies for 0.07%. Considering both funds invest in similar stocks, I consider that a high price to pay to feel good at the same time I'm investing for retirement. I don't even want to know what the average actively managed SRI fund charges, but suspect it approaches 1.5% per year.
My biggest criticism with SRI is the disappointing returns. The high fees contribute to this, of course, but it seems to me I'd be better off buying the socially IRRESPONSIBLE companies. The Vanguard Total Stock Market fund has ten year returns of 7.93% versus the Vanguard SRI Fund returns of 5.40%. If I had to work 30 years to retire with returns of 7.93%, I'd need 37.5 years to retire with returns of 5.40%. Sorry, but I'm certainly not willing to work an extra 7.5 years in order to feel good while investing.
Does It Even Work?
Others criticize SRI because they feel it doesn't make a difference, or may even work against the investor's social goals. When you buy a share of stock, none of that money goes directly to the company. It goes to the person who owned that share. The only time the company gets money is when it sells stock in an initial public offering. The CEO of ExxonMobil doesn't care one bit how often we swap the shares of his company around between us. Now, it may be true that because a socially responsible company attracts more investors (who bid up its price) that the company can get financing cheaper by selling more shares or borrowing money at a lower rate than a less socially responsible company. This effect is probably at least partially cancelled out by the fact that many companies are considered both responsible and irresponsible by different investors. Even if the effect weren't cancelled out, I suspect the decrease in investment performance for the investor is just about equal to the increase in benefit to the company. Why not just write a check and send it to the company with a thank you note? It's the same effect in the end. In fact, the more investors avoid a company (thus causing its stock price to fall) the better investment it becomes. In effect, by engaging in SRI, you are letting those who invest in “sinful companies” have higher returns. Was that really your goal?
Swedroe Calls SRI “Flawed”
Larry Swedroe, in The Only Guide To Alternative Investments You'll Ever Need puts SRI in the “flawed” category. He compared a popular SRI fund with the Vanguard S&P 500 fund and concluded that the “price of your principles” was 2.6% per year, which is similar to what I calculated above. He also noted that most SRI funds invest primarily in large growth stocks, and so expected returns even with comparable expenses would be lower than a portfolio containing small value stocks. Larry further points out that any fund which screens out some of its stocks is by its very nature less diversified and is taking on uncompensated risk, which is rarely a good idea.
The Tom Nowak Solution
To be fair, Tom points out many of these issues with SRI in his book. His book is not a defense of SRI, nor a manual written to convince you to do it, nor even a comprehensive tome defining SRI. His book is a short (93 pages, double spaced, 8 inches tall) that explains HOW you can do SRI on your terms with a minimum of expenses.
His solution, which he explains quite clearly on a step by step basis, can be performed with or without an adviser. He suggests you open a brokerage account like Folio where you can trade an unlimited amount for $290 per year. Then you run a screen on popular SRI funds, preferably ones whose mission you agree with, and identify which stocks are common to them as an initial screen. Then, you weigh these stocks by the factors most important to you, eventually arriving at 35-50 individual stocks to buy. Then you buy them at Folio and hold them for the long term, or until they become irresponsible I suppose. He estimates that in the long run and for a large enough portfolio, that costs will approach those for a more conventional index fund portfolio. So you get low fees, and you get to feel good. There are no promises about performance, of course. There are also no suggestions for how to manage the rest of your portfolio, unless your idea of a diversified portfolio is 50 large-cap stocks. What about socially responsible REIT investing? Or socially responsible bond investing? Surely one cannot do this for every slice of a reasonably diversified portfolio.
I'm still not a fan of trying to make my investment portfolio serve two masters- provide adequate returns and advance my worldview.
“No man can serve two masters: for either he will hate the one, and love the other; or else he will hold to the one, and despise the other. Ye cannot serve God and mammon.” –Matthew 6:24
If the goal of your portfolio is high risk-adjusted returns, then you cannot do SRI very well. If your goal is SRI, then don't expect high returns. Trying to do both is likely to lead to you doing neither. But if you'd like to try, I think Tom offers a reasonable path to keeping investment costs low, and thus hopefully boosting returns, at least for a portion of your portfolio. I prefer the other solution he also clearly outlines in his book– maximizing investment returns then donating to charities you support. This allows me to focus my investing on risk-adjusted returns, to get a tax deduction for the donation, and to directly impact those causes that support my worldview.