From the mailbag: How do I invest in a socially-responsible manner?

Invest well; do good.

A correspondent asks:

I’d like an ethically-based framework for my investment assets. What’s the best way to do this?

Moral in Maryland

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Hi Moral-

Socially responsible investing is a great idea in theory but dubious in practice as it’s just marketing hype. But first, what is it?

Socially responsible investing generally takes one of two forms:

1. You exclude companies from your investment portfolio that trip negative criteria.

2. You include companies in your investment portfolio that meet positive criteria.

There is no standard set of these selectors as they are based on your moral compass. Traditionally, they are related to political, environmental, social justice, and workplace rights issues. This socially responsible investing approach is also sometimes referred to as ESG — environmental, social, and governance.

What are some considerations when choosing ethically-informed investing?

1. Judging corporate behavior is tricky. For example, would a company be in or out of your portfolio if it:

• offers its employees excellent wages and benefits but builds military weapons that slaughter Palestinian children?

• is philanthropically generous but sells sugary drinks and salty snacks that are causing an epidemic of obesity and diabetes?

• produces life-saving miracle drugs but sells them at unaffordable prices?

• sells cool electric cars but promotes a plutocracy for the United States?

• sells cheap pillows but supports racists and demagogues?

• lowers consumer prices but does so on the backs of its employees and local communities?

• builds privacy-protecting electronic gadgets but does so in third world sweatshops?

2. As companies' strategy and leadership evolve, you’ll have to regularly re-assess the social responsibility status of your portfolio and that may mean frequent monitoring and trading of your investments.

3. Researching bonds and international stocks is more difficult and expensive.

4. You’ll incur additional fees to maintain this approach.

5. With tight screening requirements, you may end up with a smaller investment universe, lower returns, higher risk, or all of them.

6. With looser screening criteria, you may end up with a portfolio that looks nearly identical to a less costly and more diversified index fund.

For example, I compared Vanguard's flagship US Total Stock Market Index fund with their Social Index fund. What did I find? Here are the 10 largest holdings for the total stock market index fund on the left and the social index fund on the right:

See much difference? Nor do I as the top 9 investments are the same. As for the 10th, what makes JP Morgan Chase socially responsible but not Berkshire Hathaway? Who decided that?

I’ll also add that the top 10 holdings of the Social Index fund represent nearly 40% of the total fund value. That’s a high concentration and illustrates my point #5 above.

Lastly, there is no evidence that socially responsible investing has any effect on corporate behavior or social change. Here's Vox's take on what it calls The thorny truth about socially responsible investing.

We should all want to make the world a better place but your investment portfolio is not the most effective channel. As I said above, it’s a marketing gimmick. Consider a different path to express your conscience and social preferences.

Instead, be a low-cost index fund investor, but a socially active citizen. You can expect slightly higher risk-adjusted returns due to the lower fees and broader investment universe. Then, support the organizations you value by donating directly to them and/or organizing consumer boycotts against companies you oppose. You don't need the cheap pillows nor the chips and soda, but you’ll have a greater impact and more cost-effectively advocate for the social change you desire.