Investing in Socially Responsible Mutual Funds

You may not be able to sleep at night knowing that you own a tiny piece of Halliburton, nor will you be able to sleep at night in 25 years if you can’t afford to send your kids to college. Investing is essential to your future financial security — even if you manage to sock away $10,000 a year for 40 years, you’ll only have $400,000 to show for it, eroded by inflation, if you don’t invest it. Invested wisely, you’ll have more than twice as much and the ability to spend all of your retirement days saving the world. Until that glorious day comes, can you invest your money in mutual funds or companies whose business practices you support while still earning respectable returns?

Socially responsible investing (SRI) seeks to achieve just that by putting investment dollars into the hands of companies that are responsible to society and the environment. Here is some background information to help you get started on the path to more conscious investing.
Think about your personal definition of “socially responsible”
Within funds that fall under the category of socially responsible investments, the criteria used to choose which companies’ stocks will make up these funds can vary quite widely. Just because a fund calls itself socially responsible doesn’t mean that you will automatically be happy with the individual stocks it holds or its investment philosophy. One person might think that all socially responsible funds are good options because they generally don’t invest in alcohol, tobacco, or gambling stocks, while another person might wonder how a fund that includes stock in a major pharmaceutical company could ever be considered socially responsible. As Domini, one of the leading socially responsible mutual fund companies, puts it, “Domini may determine that a security is eligible for investment even if a corporation’s profile reflects a mixture of positive and negative social and environmental characteristics.”

Of course, you’ll want to keep in mind that some funds intentionally invest in companies whose practices they aren’t very happy with in order to practice shareholder activism, which you might like to participate in. The best way to learn why a particular fund invests the way it does is to read its prospectus. Sometimes you can even get the information you want directly from the fund’s website. Deciding what’s important to you before you start shopping for investments will help you when whittling down your options.

Despite the common misconception, socially responsible funds don’t automatically have poorer returns then their unscreened counterparts. On the other hand, just because a fund invests in socially responsible companies doesn’t mean that it will be responsible to you, i.e. make a profit. There are plenty of poor mutual funds out there no matter where you look. However, when you want to invest responsibly, your pool of available investment options shrinks dramatically. This is where things start to get tricky.

For most investors, an index fund that tracks the S&P 500 is a common recommendation, and this index has historically has returned an average of 9% per year, which will put you right on track for retirement as long as you’re regularly socking money away. Unfortunately, if you’re looking for a socially responsible index fund, your choices in the well-diversified fund department are pretty limited. A few of the big ones are the Neuberger Berman Socially Responsible Index (NBSTX), the Vanguard FTSE Social Index (VFTSX), and the Calvert Social Index.

On top of the limited selection, there aren’t many socially responsible funds of any kind that have returns averaging 9% over a ten year period. Most either have significantly lower returns or have not been around long enough to show what they’re capable of over the long term. While past performance does not indicate future returns, it can help you get a sense for how volatile a fund is, how well it adheres to its investment goals, and whether the fund has stable management–all important factors to consider when choosing a mutual fund. Of course, you could always take a risk and invest in a newbie fund and hope for the best. Just remember that what goes up must come down.

A couple of funds do show good long-term returns, like Bridgeway Ultra Small Company Market (BRSIX), Parnassus Equity Income (PRBLX), and Pax World Balanced (PAXWX). Like most socially responsible funds, though, all have somewhat high expense ratios (in this case, .67, .99, and .94, respectively). While BRSIX’s high returns, acceptable expense ratio, and low $2000 initial investment seem appealing at first glance, no young investor starting out would want to have a significant amount of money invested in micro-cap stocks, which are volatile and more of a specialized investment used to create a well-rounded portfolio than a good choice for a core holding. Additionally, the fund’s great returns came largely from one unusually stellar year in 2003 (79.3%). Other common problems with socially responsible funds include loads, an overemphasis on growth stocks (which tend to be more volatile), and an overemphasis on specific sectors.

Socially responsible investing can also take the form of investing in mutual funds that invest in foreign countries, particularly those that are considered frontier markets, which are a step below emerging markets on the investing ladder. The idea is that by investing in these countries, their economies will grow and their residents will begin to rise out of poverty. Investing this way can be tricky, though, because it can be difficult to decide whether a country needs more investment dollars to help it get its act together or whether it should be boycotted for refusing to get its act together. Refusing to invest in countries whose regimes you don’t support, or getting other to withdraw their investments in these countries, can also be effective in creating change–it helped end apartheid in South Africa.

A good place to start researching socially responsible mutual funds is the Social Investment Forum website’s socially responsible mutual funds chart. You can then do further research on any funds that appeal to you over at Morningstar.com.

While socially responsible investing may not have caught up to traditional investing yet in terms of the choices or the returns it has to offer consumers, there are at least a few funds you can invest in and earn respectable returns. The more criteria you have when choosing a mutual fund, the closer you get to having to take your chances with individual stocks or start compromising some of your values so that you don’t have to compromise your future financial well-being. Despite the lower returns and higher fees characteristic of many socially responsible funds, for people who have been avoiding investing altogether for moral reasons, investing in SRI funds is a much better option than doing nothing at all.

Photo by Tambako the Jaguar

Related posts:
What is a Money Market Fund?
How to Choose a Mutual Fund
Socially Responsible Investing, Part 1
Socially Responsible Investing