Socially Responsible Investing: Can you do well and do good?

I hate disappointing people, especially young new clients who come to me full of idealism and motivation to make a difference in the world. But that's what this post will do, so I might as well come out and say that I'm not a fan of socially responsible investing as it's normally practiced, and I usually advise clients against it. Hopefully though, by the end you'll feel better about the possibility of making an impact with your investments, even if it's not the way you thought it was going to work.

Interest in socially responsible investing (the practice of only, or primarily, investing in companies that engage, or do not engage, in certain practices) is definitely on the rise. Cerulli Associates reports that more than 50% of institutional asset managers have recently received client requests for socially responsible investing (SRI) or environmental, social, governance (ESG) mandates. Money invested in mutual funds describing themselves as investing in a socially responsible manner is one of the fastest-growing segments of assets under management. The growing interest makes sense. There's an increased focus on sustainably produced food and clothing and consumers have shown to be willing to pay a premium for local or fair-trade items, to support business models that align with their ethics. And there's no lack of headlines about corporate malfeasance, questionable business practices, lack of consideration for the environment and unfair employment policies. So the desire to put pressure on companies via investment decisions is understandable.

But the problem is it doesn't work that way. When you buy a share of stock, the money doesn't go to the company that issued the stock, but to the other investor who sold it to you (and whom you don't know). The broker who conducted the transaction gets a commission. When you sell, it happens in reverse – the money comes from the anonymous buyer to you, the seller, with a bit being diverted to the broker. The company itself isn't really affected at all by these transactions, except in a very, very vague way – you can't have sellers without buyers, and if enough people refuse to buy shares, the stock price will go down. But you can decide for yourself whether you think that will really happen.

Picking and choosing individual companies to invest in is known as active investing, and that's not a good idea. People – whether individual retail investors or professional fund managers – are irrational, make poor decisions, are subject to biases and fallacies, and let emotions get in the way. When it comes to socially responsible investing, where you might have a particular attachment to a company (say, because you know they develop green energy alternatives and have generous employee benefits), this involvement makes it even more difficult to judge an investment rationally.

A much better strategy is the one I recommend to pretty much everyone: understand your risk tolerance and invest accordingly, diversify broadly, and keep fees low. You can calculate the excess return earned by the companies you find objectionable – one way is to take a look at this list, choose the fund you would have invested in or that mimics what you would have done, and compare it regularly to your actual returns. (Remember to account for fund management fees!) Then put that money to use in ways that can really move the needle: supporting political candidates that will further your causes, buying items produced or sold in ways that align with your ethics that might be more expensive than their competitors, and engaging in public education campaigns. Utilizing simple index funds allows you to capture as much return as possible by keeping fees low, and avoids participating in putting pressure on companies to deliver certain results, possibly at the expense of more costly or difficult to implement, but more fair, business practices. 

Ultimately, how you choose to invest your money is your decision, and if you decide you just can't stomach getting oil company profits, that's fine. Do what feels right to you, but make the most informed decision you can. My clients know that I constantly beat the drum of controlling what you can control – in this case, it's the fees you pay, and to whom you pay them – if you're on your own, Vanguard is a great choice because they are investor-owned; if a fee-only advisor manages your money for you, ask them to tell you more about their custodian and the custodian's practices); if you're working with a traditional commission-based advisor, take a close look at your statements and think about whether the money you're paying for your investments would be better spent going to a more worthy cause.