[Hey hey! Bringing you a post today from an up and coming blogger on the scene, Tom of HighIncomeParents.com. Been really enjoying his blog lately, so it was a nice surprise to get a fresh article from him to post up on our site here :) Check it out and let me know what you think in the comments! I had NO IDEA about some of the stuff he mentions in the IPO/stock market area??]
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When I first thought about this topic, I was conflicted. I care about this earth and its amazing natural beauty. I care about the people that live on it. I’ve devoted my life to treating these people medically and helping them to be healthier so that they can live a more fulfilling and enjoyable life. (I’m a physician)
When I get a chance to stand at the North Rim of the Grand Canyon or hike to the top of the Mist Trail in Yosemite, I thank the people before me who thought to preserve places like that for generations to come. Buying a meal for someone in need or teaching others to care for their health brings me joy.
I want to leave this earth a better place than when I came into it. As I’ve worked for and had the fortune to gain more and more wealth, I want to use that wealth to improve the people and the world around me.
Naturally, I look for the best way to use the money I’ve earned to promote these ideals and values. I start to look into companies that share my ideas and values. I know there are people all around me that don’t hold every one of my values. In fact, I would be surprised if there is another person, let alone a company on this Earth that matches me idea for idea.
I want to invest in a way that promotes my ideas, but the more I look into this, the more difficult it becomes to achieve.
When I sat down to develop my investor policy statement, I wanted to find investments that meet my values. I started to look into socially responsible investing.
What is socially responsible investing?
Socially responsibility investing (SRI) is a strategy where an investor preferentially only buys stocks or other investments that support a more socially contentious idea. This could consist of companies that promote women or other underrepresented groups in leadership roles. This could be mutual funds that buy companies with a commitment to improving environment factors. Ethical Corporate Governance in business practices is another value frequently cited.
You could exclude companies considered evil, whatever evil is to you. You could only invest in companies that promote good, whatever good is to you.
It is difficult to pinpoint an exact definition. Overall, it’s a strategy that makes an investor feel better about the money she is handing over to different funds. The funds then invest in corporations to earn her more money and promote her beliefs.
What is the purpose of SRI?
I think the purpose of SRI is two-fold. When we invest, the idea is to make money. Why invest if you don’t want to make money? If you want to affect so much change that free markets and making money is not your ideal, then no need to bother investing in the first place. Increasing your net worth has to be number one when investing. The second is to promote your values and beliefs by investing in companies that will further those beliefs.
Can we really do that?
Let’s look at the process of investing in a company. A company grows large enough that its administration wants to take the company public. They go to an investment bank (like Morgan Stanley or Goldman Sachs) and make sure they meet all the criteria to make an initial public offering (IPO).
The investment bank does its due diligence and values the company. They make a bid and underwrite a valuation of the entire company or set up a syndication of several investment banks that will each underwrite a portion of the financial commitment to the company. This diversifies the risk. Then the investment banks market the IPO. They try to create awareness and buzz so that when they offer the stock to the public, the bank gets a high price.
The investment bank has already bought the shares from a company before they even go to IPO. Even if an investor buys the shares at IPO, he is buying them from the investment bank. The investment bank makes money on the difference in the shares they bought from the company and the sale to the public.
Unless you are a big time trader with an inside track to the investment company, there is never an opportunity to buy shares from the company itself.
Then all the shares that are traded on the exchanges are from institution to institution or individual investor to investor. The only time a company may make more money from selling stock is if they do a secondary offering. Of course, the investment banks underwrite those too.
So your money never goes directly to the company you’re investing in?
Nope. Okay, so maybe you say, “Fine, but if I don’t buy an evil company, their stock will go down and maybe the company will go out of business.”
Unfortunately that isn’t true either. There is a one way cause and effect in the market when it comes to stock price. If the managers run a company poorly, losing revenue and earning, and generally doing things that harm the company, then eventually the stock price drops.
A group of investors banding together to only buy companies that hold a certain ideal or promote a certain social good could artificially lift a stock up. The market is so vast though that it will only be short lived. Others (quants, traders, computer algorithms) will sell a company they think is overvalued because a group of people artificially bid it up higher due to its social responsibility characteristics. The “profiteers” only take into account its business practices and valuation. They’ll swoop in and sell shares, bringing the stock back to its fair market value.
Let’s look at some SRI funds
SSGA Gender Diversity Index ETF (Ticker SHE) — This is a new fund that seeks to invest in companies that advance women through gender diversity in the leadership roles at the board and executive level. Who doesn’t want to see women have as much of an opportunity to lead our great companies into the future? This seems like a great idea on the surface.
Now lets look at the top 5 holdings. They are Pfizer, Pepsi, 3M, Amgen and Mastercard.
What if women’s equality and the advancement of women in leadership is important to you, but on the other hand you also disagree with promoting sugary drinks to children (Pepsi)? You also think drug companies promote unnecessary drugs to people that could benefit from other treatments (Pfizer, Amgen), and you worry about the debt crisis and think credit card companies (Mastercard) promote bad behavior. How do you reconcile those beliefs?
These are just some examples that could make it difficult for people to invest in funds that capture all their values. Don’t forget the underlying fundamentals of the fund itself too. In this case, the expense ratio is only 0.2%, one of the lower ones in the category, but that is still 4-5 times higher than a total stock market ETF.
Lets look at the return over the last year:
As you can see, the fund is too young for us to see a true track record. It underperformed the total stock market by over 5% last year.
iShares MSCI KLD 400 Social ETF – Now let’s look at another ETF, the iShares MSCI KLD 400 Social ETF (Ticker DSI). This EFT holds companies such as McDonald’s, Walt Disney, Time Warner, and Coca-Cola.
What if you are very committed to minimalism? You also think society, in general, is wasteful and over indulgent? Can you own Disney or Coca Cola even though the fund promotes other aspects of social responsibility?
This fund started in 2006, and its expense ratio is 0.5% – about ten times greater than a total stock market fund. Here are its returns:
This fund has underperformed a bit more than the difference in its expense ratio. Keep in mind, these funds are actively managed.
Social Index Fund — Even Vanguard has the Social Index Fund (Ticker VFTSX). These managers examine companies for certain social and environmental criteria. They also exclude companies involved with weapons, tobacco, gambling, alcohol, adult entertainment, and nuclear power. Its expense ratio is 0.22%, another one of the better values.
Here are their returns:
As you can see, the long-term returns are inferior. The fund has a higher expense ratio than the Total Stock market ETF.
Are there alternatives to SRI?
Yes, you could create your own socially responsible fund! However unfortunately, going back to the previous ideas, you don’t really contribute to the profits of the company. You do have a vested interest with the companies you select though, but buying and selling of the stock won’t contribute a dime to the company’s bottom line.
Is index investing social responsible?
The answer to this question is, it depends on your definition of social responsibility. When you buy a total stock market index fund, you have a vested interest in all that participate in that market doing well. You don’t contribute a dime to any of the companies the index fund holds, but you do want each person in the workforce to show up and do the best job they can to make profit and return value for their services.
Another perspective is that by being a shareholder of what you consider a socially irresponsible company, you can vote for the board to change practices with which you disagree. You could probably do more good as an owner of an ethically disagreeable company, than someone who boycotts its stock.
What about the fund doing the investing?
As for the fund itself, you do choose whether you will support or not support that company. I think as far as financial companies go, those that keep costs low and maximize investor returns are a pretty good choice.
Companies like Vanguard fit the bill. They’ve had a commitment to help investors keep more of their money longer than any other broker. Other companies that concentrate on high value and low costs are also looking out for their investors. The research shows that keeping costs low helps investors generate higher returns.
Then the investor can do things like donate to charities or set up a donor advised fund. These brokers and their diversified low-cost funds give investors opportunity to work less time in a high stress, less healthy job. They can then retire earlier to a life of more relaxing life and concentrating on benefiting their fellow man. We can use our profits to affect real change around us and make a personal difference in the lives of the people we love.
It might even help the investor live longer so she can dole out even more kindness, and spend more energy seeing the beauty of the world and sharing it with others.
I love the idea of socially responsible investing, just like I love the idea of active fund managers returning more profits than an index. The way the system is set up, however, it just doesn’t happen.
If we put our hard earned dollars towards the fund companies that have our best interest at heart, we can put our earnings toward the best interests of our planet and our fellow citizens.
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Tom is a doctor, husband, and father of five with a passion for parenting and finance. He started HighIncomeParents.com, a parenting and personal finance blog that helps high income parents educate and mentor their kids to become financially, emotionally, and intellectually self-sufficient. When he isn’t hiking, skateboarding, riding BMX, or jumping on the trampoline with his wife and kids, he is reading and writing about personal finance.
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“Is Socially Responsible Investing Possible?”
I think it’s an oxymoron.
Hmm. So you’re saying investing (or making money from the work of others) and being socially responsible is incompatible? I guess I can see that. If you have the ultimate good at heart for that person, you should make sure every ounce of his/her effort contributes to his/her well-being and not make money off of it.
Interesting point. Now we are getting really deep. :)
Tom @ HIP
I think that broad index investing in a socially responsible manner isn’t possible, but that’s OK. Talk with your wallet instead.
I’m not sure it’s easily accomplished. But I think I prefer investing where I have more of a chance that my money will work for me, then choosing to use my future funds and time to give back.
For e the issue is if your investing is creating a problem or perpetuating injustices, how much can your giving on the back end really do/ fix? Why not try to not create the problem in the first place?
I have been looking at companies like Swell Investing and Ellevest to put some of my investment dollars in more socially responsible funds and more conscious managers. I’d love to hear an opinion on those.
Katherine,
I just looked those companies up and they seem to have good intentions, but they are expensive. Swell takes a 0.75% investment fee of funds under management each year. That is about 15 times more expensive than a Total Stock Index Fund from Schwab or Vanguard. It will be difficult for them to beat a passive fund like that over a 20,30, 40-year investment career. Swell also points to the KLD 400 beating the S&P 500 since its inception 25 years ago, but I pointed out in the article that it has underperformed the last 10 years. That happens when funds beat the market for 5 or so years and then just keep pace after that. It’s great for the initial investors but then the later investors (like now) don’t see the returns that the company is touting.
Ellevest charges a 0.5% fee on management, also 10 times more expensive. That makes a significant difference over an investment career and gives more money to Ellevest to use as they see fit (maybe you agree, maybe you don’t, it’s hard to know) and less for you to possibly see a direct impact from your own giving that isn’t tied to the goal of investing.
Tom @ HIP
Thanks for the quick and thorough reply.
You hit it on the head. Everyone has their own beliefs and each fund is going to conflict with it in some way.
I didn’t even realize they were massive cooperations you are “supporting” through these funds. They don’t even know it either.
When we are talking about a corporation, I think it’s impossible to account for everything they are doing and make sure it lines up with my beliefs. I like that you put supporting in quotes because that is a whole other debate. What does it meat to “support” a company.
Tom @ HIP
Completely agree! I think Tom is spot on with this quote:
“If we put our hard earned dollars towards the fund companies that have our best interest at heart, we can put our earnings toward the best interests of our planet and our fellow citizens.”
While the idea of SRI is very noble, I have come to the conclusion that I would rather be in a financial position (largely due to good investments) to be generous and impactful with my giving of money, time and energy to causes I am passionate about.
Great post for a Friday…thank you!
Right on the same page with you Mrs. AR. Have a great weekend.
Tom @ HIP
There are far too many ways to game the system for SRI. Also, the highest returning stock ever is a tobacco company. If you disagree with smoking, is not investing in it going to stop smoking or stop someone else from investing and getting those outsized returns?
Very true FP. If the objective of SRI is impact, there is pretty much no chance we are going to impact a company by excluding it from our portfolio.
Tom @ HIP
Stop making me miss cigars!! (haven’t picked one up in 3 years – ack! :))
Completely agree. I think the way to be socially responsible is twofold: 1 – how you live your life and 2 – how you spend your money.
You spending your money on items that are made in a responsible manner has a much bigger impact than the trickling down of stock investments!
Also, another tough pill to swallow – VTSAX has a lot of shady companies in it – like private prisons and cancer causing tobacco companies!
https://www.fool.com/investing/2016/10/16/are-there-private-prison-stocks-in-your-portfolio.aspx
http://portfolios.morningstar.com/fund/holdings?t=VTSAX
When I found that out, I wasn’t able to sacrifice my future to be noble. Just like I wouldn’t give all of my money away now when I need it (who knows when I’m dead though).
I’ve read an example before of making two choices. Say you have a son that works for a company. You want to help your son.
What is going to help him more? Throwing tons of money at the company stock or paying for his college, car payment, house payment, etc? It seems to me we can have a much bigger impact by directly giving.
Tom @ HIP
Great analogy, Tom.
I totally agree. In fact, let’s take it one step further. If you have money in the bank then you are likely directly contributing to something you disagree with. Banks loan money to anyone and everyone. Money is fungible. Thus if your bank loans to something you don’t like then technically your money contributed to their ability to do so. Loans go directly to the company. If you really want to feel good about yourself take your proceeds and donate them based on your beliefs. Don’t invest that way.
That’s a really great point FTF. If we don’t want “bad” people using our money stuff it under the mattress. It’s just not realistic.
Tom @ HIP
Very interesting insights here. It seems like, aside from looking at companies that are divested from arms or fossil fuels or obvious things like that, this gorgeous goal is an uphill battle. And if you are still invested in the market overall, as most of us are, does it really make much of a difference? I have to be honest, and this may seem like blasphemy, but I really don’t mind if a company I find to be net harmful goes down in value, even if it’s somewhere in my S&P fund. This may be self-defeating, but I honestly feel this way. I cheer when big banks get hit with big fines for their wrong-doing, even if they are most likely in my financial industry fund. The mechanics of our society make it very difficult try to find some small slice of American-style financial security without investing in companies whose world views you find abhorrent. I guess the brunt of the money we allocate for doing good just has to be done in other more direct ways. Trying to do it through a financial system that is designed to enrich massive corporations and their CEO’s might be a fool’s errand. We might ultimately have a greater direct impact with the decisions we make as consumers.
That’s the conclusion I’ve come to. The system just doesn’t make it possible to make an impact. I’d rather see the impact directly. Investing in a SRI fund is like getting a participation ribbon. You show up but don’t have much impact beyond that.
Tom @ HIP
I think impact investing is a brilliant idea. The U.S. government, foundations, and private donors have been looking at ways to connect philanthropy with market mechanisms.
One of the main challenges of impact investing is selecting the right indicators to measure success. But I think this is indeed a promising areas for investors who care about making an impact.
I like the idea but like you said the indicators and implementation is the difficult part. The devil is in the details. So far I haven’t been impressed with impact opportunities. It seems like more of a way for those fund managers to make extra money than a direct impact on the causes I care about.
Tom @ HIP
I agree that it’s difficult to find a fund that hits all of your personal ‘social responsibility’ requirements. Thus it makes sense to earn on your investments as responsibly as you can and then make contributions/donations to society as you see fit. Nice post, Tom!
Thanks Amy. That’s my plan. It’s not perfect but the best I think we can do.
Tom @ HIP
It feels impossible to engage in SRI. There are so many ways for people and companies to be terrible to people. You can’t know what HR department is overly protective of the company’s reputation and not protecting vulnerable workers from harassing managers.
This is a big reason I am not into DGI and prefer indexing. So many of the companies with dividends do terrible things. I think it is messed up that Coca-Cola is able to buy up all the water in some regions and then charge the locals for something they’ve used for generations. That’s just one example, but so many corporations do things I just don’t jive with. The moral blow feels much smaller in an index fund; it may be just semantics, but it feels a little different and hopefully at least some of the companies in the index do some good and aren’t a net evil to me.
ZJ. There is a study that shows companies with the most regulations and policies that make it more socially responsible are more likely to break those policies in future years. For sure, It is really difficult to make your investments line up with your values.
Tom @ HIP
Oh man, I didn’t even consider this. With investing it seems like our focus is always on money and returns; I never considered the social/environmental impact of investments.
Hopefully I haven’t thrown yet one more thing on your plate to worry about Mrs. Picky Pincher. Forget you’ve ever been here. ;)
Tom @ HIP
Interesting post. Trying to figure out how to invest based on my set of beliefs seems like a bad idea. I prefer “set it and forget it” or a simplistic approach.
I am with Chris’s comment, talk with your wallet. Make local decisions that are in line with your ethics. My $10 in Halliburton is not why they are a rich conglomerate nor do they care. My $10 at the coffee shop that donates to orphans does make an impact.
Start a new slogan DDD. Invest globally. Impact locally. Maybe it will catch on. :)
Tom @ HIP
I like it!!
I don’t really believe in social responsible investing. It’s mostly because I think all public corporations are bad. There might be some exceptions, but most of them are geared toward making profits. That means screwing their workers and enriching the people running the companies. I prefer to donate to good causes when I want to improve the world.
Joe,
I’ve daydreamed about a world where companies could only grow to 10 employees or some small number. I’ve wondered what that would look like. Would there be more collaboration between different businesses and more teamwork? I don’t know. There are a ton of variables but it does seem as corporations grow the workers become nameless numbers instead of human beings. Maybe if we kept things smaller as a society, we wouldn’t discount workers as much.
Tom @ HIP
that would be fascinating!! would probably take 100x longer to get new products out the door, but maybe it would make all us consumers appreciate everything we’ve got even more ;) and then for all those who “need” to upgrade it spreads that out longer too, haha…
A couple of years ago I analyzed the idea of ethical investing, and came to the conclusion that it is impossible. Anything you say and do could be viewed as violating someone’s ethical rules.
“Investing for a profit is very difficult as it is today. By applying arbitrary rules in investment selection, that have nothing to do with the underlying profitability of the business, you are essentially limiting yourself to never investing in anything. Your goal as an investor is to earn money, and not to be a moral/ethical arbiter for the world.”
Totally agree. The objects of investing is to make money. Use that money to give to areas that don’t make money but advance your values.
Tom @ HIP
Attempting socially responsible investing feels a lot like flapping the wings of a butterfly and wondering if that that will result in a tornado somewhere. The cause and effect are so far apart that it is near impossible for us to measure actual impact.
So I’m on the side of let my money grow, and then I’ll let my money talk in ways that are more easily measurable.
The butterfly effect of investing. Sounds like a good book title. :)
I totally agree. We all want to make an impact and I just don’t see it by excluding certain stocks based on values.
Tom @ HIP
I’m glad you brought up IPO. Never buy a company within the first 6 months of going public, there’s no deal to be had.
There’s no perfect good in this world when there’s money involved (and money is always involved.) There was one post on Reddit where one guy exclaimed he’s not going to invest in “evil companies” and asked for recommendations on SRIs or he’s going to stop investing altogether. Poor guy was laughed out of the forum.
The way IPOs work is very interesting to me. I think it’s a good thing for investors to be aware of how the overall system works. That was a big reason I included it in the article.
Tom @ HIP
Hammer, meet nail!
Love the comparison between pepsi doing good for the world but also selling sugary drinks. That is what makes investing so much fun, you’re in control of the decisions and get to decide which you weigh more !
After writing the article I try to thing of investing like a train ride. I buy the ticket but I don’t have any control over where we are going. Depending on my goals, I better pick a good conductor and train company. If I don’t we are both going someplace I don’t want to go. If I do hopefully they are taking me someplace that will help me accomplish my goals.
Tom @ HIP
This was a fascinating post. I think that it is good that there are funds and ETFs that focus on socially responsible companies. There are people who feel strongly about investing in these companies based on their shared values. For me, I strongly believe in women’s rights and being kind to the environment. My approach to investing, however, is to stick with the broad indexes. My approach to supporting causes is to donate money or time to causes I feel strongly about.
I think your approach is best. I think for the people that invest in companies based on a companies values, they are probably affecting little change. The one thing they are changing is the value of the fund managers bank accounts by increasing them. I’d rather see people make a bigger impact with direct donating regardless of investment return.
Tom @ HIP
This post poses a great question! One I’ve thought far too little about, frankly.
I know the Stash app offers asset packages based on social and environmental causes. If you are passionate about the environment for example, you have the option to invest your Stash dollars in the Clean and Green Fund (which buys you shares of iShares Global Clean Energy ETF). Or you could invest only in socially responsible companies with Stash’s Do The Right Thing Fund (iShares MSCI USA ESG Select Fund).
So Stash makes it easy to kinda sorta invest in a kinda sorta socially responsible way. But as this post points out, it’s not maximizing your investment or maximizing your potentially positive social impact.
I haven’t played too much with the Stash app but I’d be interested to see the difference in costs among those funds you mentioned. If I’m just putting more money in the fund managers pockets and not advancing my values, I don’t get too excited about that.
I’m glad I made you think a little bit more :)
Tom @ HIP
Great post, Tom! I especially appreciate your point about being able to affect change from the “inside” as an investor through proxy voting.
Personally, I put most of our retirement savings in index funds for the same reasons you listed. I do have a small chunk that I buy individual stocks with and have chosen companies that align with my values.
My theory is that the companies following these values are setting themselves up for long-term success, so they are a worthwhile investment.
So far, that’s led me to a couple that have performed well in the last 5 years but we’ll see what the future holds :)
Thanks, Chris.
I don’t know how much difference one proxy vote is gonna make. It seems like the board of directors run unopposed for the most part when it comes to shareholder votes, but it’s better than not having a vote at all.
Most of us are too small to make a difference in a huge corporation with our votes but we can make a difference to the park near our home or the neighbor who’s water heater blew up and car transmission crapped out. That’s why I invest and give the way I do.
Tom @ HIP
I used to be a Sustainability Program Manager and Energy Engineer, so I’m very familiar with Corporate Social Responsibility. The Pepsi stock is a great example of how there can be a lot of tradeoffs, unfortunately. There is also a lot of ‘greenwashing’ that goes on with companies, so research is a good idea. There is something fairly new called a “B-Corp”. I believe there are only about 100 companies that have this structure, Patagonia being one of them. It puts the Triple Bottom Line of People, Profit, Planet over just profit to stakeholders.
Just looked up greenwashing — “disinformation disseminated by an organization so as to present an environmentally responsible public image.” Boooooooooo…
One way to do socially responsible investing is to submit or vote for shareholder proposals.
Each year, shareholders can submit proposals to the board of directors, and shareholders may vote on those proposals to show where they stand on the issue as the company owners. This can influence what the direction the board takes the company in.
One of the very few downsides of index funds is that investors give up their voting rights to the index company. Vanguard, for example, is the largest shareholder for many publicly traded companies, and votes “no” on most shareholder proposals, because they try not to take sides, maintain a pretty simple methodology for voting, and they’re transparent about all their votes.
For example, one shareholder proposal for Pepsi was for them to adopt quantitative renewable energy goals, and Vanguard voted no. Another shareholder proposal for Exxon Mobil was for them to provide a report to shareholders on all the lobbying payments they make to politicians, and Vanguard voted no. A shareholder proposal for Amazon asked them to use sustainability goals as one metric of executive compensation, and Vanguard voted no.
Thanks for the info. Good point about giving up voting rights with index investing.
My understanding is these votes are already decided in a lot of cases and only there for lip service. I’m sure there are exceptions but if I owned a few thousand shares of any company I doubt my vote would make much of a difference.
At least you have some theroretical say in the direction of the company with direct ownership but I doubt it makes much difference.
Tom @ HIP
I agree- it certainly makes very little difference per shareholder, in the same way that individual votes make very little difference for who gets elected president of the country.
One reason that the shareholder votes are already mostly pre-decided is because so few people vote. Major indexing companies usually side with the board of directors, and votes that abstain essentially count against shareholder proposals. With so much of it running on autopilot, the results are highly predictable and turn out in favor of the board of directors most of the time. But it’s a price we pay for convenience.