Part of building mutual strength is supporting the communities and causes you believe in. And more often than not, you do that with money. That can range from decisions about where to shop to strategies about where to invest.
Socially conscious investing — also called socially responsible investing, socially selective investing, or social impact investing — tries to accomplish just that. It screens companies for environmental, social, and governance (ESG) factors, such as their record on air pollution, worker pay, community support, or shareholder accountability.
Individual investors can screen companies on their own to create a portfolio that will help them meet their financial goals while making a positive difference in the world. Investors can also choose from baskets of investments — mutual funds and exchange-traded funds (ETFs) — put together by investment companies that handle the screening work.
Will you pay more to do good?
If you shop in a way that supports your values, you know that you sometimes have to pay more for products that are made in ways you endorse by companies you approve of. Organic, fair-trade coffee and sweatshop-free clothing are often more expensive than their conventional counterparts.
It’s logical to assume, then, that you might have to pay more for ESG investments that do the same. The problem is that just as paying more for fair-trade coffee means less money in your bank account, higher investment fees can mean less money in your brokerage account. (Related: Investing basics)
What’s a baseline for investment fees? Typically, for traditional index mutual funds or ETFs with rock-bottom fees, you might pay an expense ratio of just 0.03 percent to 0.15 percent for a domestic stock ETF from one of the major brokerages dealing with such investment vehicles. That means for every $1,000 invested, you’ll pay $0.30 to $1.50 per year in fees. That doesn’t sound like a lot, but once your portfolio contains $100,000 or more, that figure increases to a more significant $30 to $150 a year.
So how do the fees for socially conscious investments compare?
“Historically, on average, socially selective funds underperformed the market for the same reason other name-brand, actively managed funds did: high fund expenses,” said Jason R. Escamilla, CFA, founder of ImpactAdvisor in San Francisco, in an interview. Socially selective funds were a niche market that required a marketing and sales budget to attract investors, he explained.
“Today, you can find socially responsible or socially selective investment options with expense ratios at 0.20 percent and lower,” Escamilla said, thanks to newer, algorithmically constructed ETF portfolios.
Will you sacrifice returns to follow your conscience?
And what do the returns of socially conscious investments look like compared with peer investments without a focus on the triple bottom line of people, planet, and profits?
“Most investors believe there is a trade-off between one’s values and one’s investment returns. This is left over from the days of overpriced investment products,” Escamilla said.
Indeed, 27 percent of respondents said they would expect companies that prioritize their impact on the environment and society to earn lower returns than the market in general, according to the Financial Industry Regulatory Authority (FINRA)’s Investor Education Foundation survey in the fall of 2021. Forty-one percent said they expected these companies’ returns to be about the same as the market in general, while only 14 percent expected them to be higher. (The remaining 17 percent said they didn’t know.)
To investigate whether investors pay a performance price when they opt for ESG stock funds, Vanguard senior investment strategists Jan-Carle Plagge and Doug Grim looked at 15 years of data on ESG mutual fund and ETF performance compared to that of all U.S. stocks. They found that ESG funds do not categorically perform better or worse than the overall market, but specific funds do. Therefore, investors should assess ESG investments on a fund-by-fund basis.1
Other research has found that, on the whole, companies whose stocks make up ESG fund portfolios actually have a worse track record on environmental and labor issues than companies whose stocks aren’t included in ESG portfolios. In other words, ESG investors may be accomplishing the opposite of what they hope to.2
Other challenges in socially responsible investing
Following your conscience might mean eliminating companies that profit from any of the following: adult entertainment, alcohol, animal testing, contraception, deforestation, gambling, genetically modified organisms, human rights violations, nuclear power, thermal coal mining, or weapons, to name a few.
Or it might mean including companies whose practices are in line with your beliefs when it comes to matters such as board independence, business ethics, environmental protection, executive pay, gender and racial diversity, labor standards, privacy and data security, religious issues, renewable energy, or worker pay. What each investor defines as responsible or irresponsible depends on their personal beliefs.
Perfectly meeting your personal definition of socially responsible, then, might only be possible by selecting individual stocks and bonds. But not everyone has the time or know-how to do that.
Further, failing to properly diversify by concentrating your investments in one industry or in just a few companies is the biggest risk in socially responsible investing, said Robert R. Johnson, a professor of finance at Creighton University’s Heider College of Business and chairman and CEO of Economic Index Associates.
If you devote a significant portion of your portfolio to one industry, then your portfolio may suffer more if a negative economic event hits that industry than if you held a more broadly diversified portfolio. Underdiversification is a risk that is preventable and that is not unique to SRI, though. (Learn more: Knowing the financial eggs in your basket)
As mentioned earlier, investors can overcome the limits of time, knowledge, and underdiversification by investing in funds. You may sacrifice perfect alignment of your beliefs and your portfolio holdings when you invest in a fund, but don’t let the perfect be the enemy of the good.
Trying to “do good while doing well” — to select investments that match your values while earning the same returns you would without implementing such a screen — can be tricky. Diversified ESG funds may give you the best shot at not sacrificing returns but may only be loosely aligned with your values. More narrowly focused ESG funds might align better with your values but will likely rise and fall more often as that industry’s fortunes change, potentially giving you more volatility than you might want.
If you need help developing a socially conscious investment plan, consider working with a financial professional who can help you weigh and prioritize your goals.
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This article was originally published in May 2020. It has been updated.
1Journal of Portfolio Management, “Have Investors Paid a Performance Price? Examining the Behavior of ESG Equity Funds,” February 2020.
2 Harvard Business Review, “An Inconvenient Truth about ESG Investing,” March 31, 2022.