Posted By: CFP&WM On: Nov 23rd, 2015 In: Money Matters Comments: 0

Avoid Problems With Socially Responsible Investing

Socially Responsible Investing is a big deal as more and more investors are wanting to “do good” with their investments at the same time as building their nest egg to fund their goals. However, all that glitters is not gold.

When it comes to Socially Responsible Investing (SRI) there are several potential problems of which every investor should be cognizant:

● Losing sight of your investing objective
● Too little diversification in your portfolio
● High expense ratios cut into returns
● Commissions
● Lack of objective information in selecting SRI investments

The first objective for any investor should be to invest successfully i.e. earn good returns for the level of risk taken. The strategy employed to achieve that objective can be the SRI approach (to do good) but that must be a lower priority than the first objective of a good return. For most investors, it simply would not be prudent to have the “do good” be the primary objective and accept low investment returns.

This is consistent with intent of the majority of SRI investments. In the prospectus of virtually every SRI offering, the objective is “investing success” such as capital appreciation or current income with capital appreciation. The method to achieve the SRI approach is not the primary goal nor should it be yours.

A properly diversified portfolio includes a mix of stocks and bonds, being in balance between U.S. and foreign, Value versus Growth and Large Cap versus Small. Diversification is very important because it is the best way to minimize your level of risk.

As an example, let’s say that you have a passion for alternative energy and at the end of 2009 you decided that, come the new year, you would invest all your money equally among three different alternative energy investments, namely Market Vectors Solar Energy ETF, Guggenheim Solar, iShares S&P Global Clean Energy Index. Had you made those investments on 1/2/10 the result would have been an average loss of 39% a year over the following three years.

Why? In the above example, the investor had assumed that because he/she had three different funds with different fund managers so that the portfolio was then properly diversified. However, because the funds were all within the same industry, the portfolio was not diversified at all. That particular sector was the worst preforming sector of all listed. Had the hypothetical investor been better diversified there would not have been the huge losses.

Many SRI Investments have higher than average expenses, which can detrimentally impact your long-term performance. Of the 438 SRI mutual funds and ETFs, the average fund expense is 1.23%, which is similar to non-SRI offerings. Be aware that some SRI funds, including those from Timothy Plan, have expenses, which are over 3% a year.

The U.S. Labor Department has stated that over time, excessive fees of just 1% a year can result in 28% less in your account when you retire. That could be $720,000 compared to $1,000,000 if your fees were lower. You would be well served with low cost funds such as those available from Dimensional Advisor Funds (DFA) or TIAA CREFF, or Vanguard, which well under 0.5%.

Many ESG investments are sold by a salesperson or directly from the mutual fund family with commissions that can be as high as 5.75%. That means that if you invested $100,000 into a handful of SRI equity funds, as much as $5,750 could go the salesperson and his/her company, which leaves you with only $94,250 of investments. Always try to purchase “no load” or non-commissionable investments because there are plenty available.

If you are considering investing in SRI, where can you turn for objective advice? Unfortunately, there is no single website which offers all of the definitive answers and information on SRI investing. However, the Forum for Sustainable and Responsible Investment website does have a link to past performance of some SRI funds. Another site, Social Funds, also has a good deal of information though it, too, is somewhat lacking.

Let’s look at one example of the limitation to these sites. Say you have decided that you wish to purchase a “Large US Blend” mutual fund but want a Socially Responsible Investment.

● There are 1,578 Large Blends available but only 66 of those are SRIs;
● If you exclude those with commissions you are down to 48.
● When you screen for those in the top half as to return for the risk taken you are left with 19.
● Then, you want one that is in the top half of its peer group relative to returns for the past 1 and 3 year time frames. So now, after that last screening, you are down to 12
● But 3 of those have a minimum purchase amount of $100,000 or more and 2 are designed for 401(k) plans. So, you are left with a choice of 7 Large Blend SRI options.

The only problem is that of those 7 options only 1 is listed on Social Funds and only 2 different funds on The Forum for Sustainable and Responsible Investment. In other words, it is very hard to pick the right SRI investments without professional help.

What is most distressing about the lack of available information on SRI offerings is that the majority of advice on SRI investments is coming from salespeople, either at a Broker-Dealer such as Merrill Lynch, Edward Jones or Morgan Stanley MS +0.00%, or a bank such as Wells Fargo. Whenever commissions are involved there is the danger of conflicts of interest.

If you are considering SRI and would like objective advice, consult with a CFP(R) professional that obide by a Fiduciary Oath. Check with Garrett Planning Network or NAPFA.

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