Socially Responsible Investing: You Better Think Twice

A while back I wrote an article that outlined four index funds that create a safe, wealth building socially responsible investment portfolio.

As I was writing it I knew one day I'd need to address the moral question of why I recommend having a portion of your investments go to ethically bad companies. And last week a reader, Mati As, asked pretty much that question.

I thought the question was so good that it warranted a new article. So Mati, thank you!

Here's Mati's question and my response:

Hi Ryland
I would like to see the end to your conversation regarding socially responsible vs. socially irresponsible companies. I feel like taking capital away from socially irresponsible companies (coal-power, private prison systems, etc.) is a strong political statement, as well as a way to restrict the ability of these companies to continue to do the irresponsible things they do. Furthermore, what about enabling the potential of socially responsible companies to positively contribute (/change) to our society? 
Thanks for your time
Concerned Investor

Thanks again, Mati. To be clear the only stock market investment vehicle I recommend is the index fund. I definitely don't play the one-company stock game. And unless you've got a Warren Buffet track record, I recommend you don't either.

So this is a total market index funds vs. socially responsible investments (SRIs) discussion. And to make this response easier to comprehend I'm going to use Vanguard's VTSMX as a proxy for the total market. 

First let's make clear the distinction between SRIs and VTSMX ethically. The comparison is not simply good vs evil. It is more like ethically good (SRIs) vs a mix of ethically good and ethically bad (VTSMX).

Now that the distinction is clear, I have two considerations in my decision: 1) Where can I have the greatest impact for my self, and 2) Where can I have the greatest positive impact in the world or my community?

To start, how much positive change will I and the world see from me contributing to SRIs?

By investing only in SRIs my money would go only to companies’ upholding a socially responsible standard. Of course, yes, I'm a fan of this.

In part, this action could bring about two things: A) It could cause the ethically bad corporations to shut down or change their bad practices, or B) It could bring about a noteworthy 'good' change in the world or my community.

Let's start with A. Realistically not investing your money in VTSMX will have minuscule-to-no impact on shutting down or changing public companies' ethically bad practices. 

Well then, what if the entire world's money moved from VTSMX to SRIs? Then hell yeah it would shut down and change a ton of public companies' ethically bad practices!

But as optimistic as I am, I don't foresee the entire world changing their investments from VTSMX to SRIs just out of moral vindication. (*great discussion on this in the comments below)  

Even if we did see a massive shift, it would cause VTSMX's share price to drop considerably. And undoubtedly there would be investors who would buy up VTSMX at its new cheap price. This would then push money back into VTSMX, and the impact would be lost. 

So we can say that investing in SRIs would not shut down or change any companies ethically bad practices.

Now for B: I think investing in SRIs to support socially responsible companies may help bolster existing good practices. But I don't believe you would see any noteworthy affect. 

In other words you would not be able to look back and say, "That good happened because I put my money in SRIs!"

So as noble as "socially responsible investments" sounds, I don't see contributing to them resolving any ethically bad practices or stimulating any noteworthy 'good' change. The world and your community would be the same whether you put your money in SRIs or VTSMX.

Now what about the difference in SRIs vs VTSMX from the perspective of a return-centric investment vehicle? 

From a quick look, SRIs have about a 1.5% greater fee cost than VTSMX. (That is huge!)

Let's say I invest $20,000/yr over the next 30 years, and that both investments grow at 7%. So net fees VTSMX pulls in 7% interest and SRIs pull in 5.5%. 

At the end of this 30 year period the SRI's fees will have eaten away $440,000! That's $440,000 more I would have if I were to have invested in VTSMX. If this doesn't shout, "Holy shit! What an epic opportunity!" to you I don't know what does.

You could use this money to do good for your community, neighborhood, or favorite causes in very significant ways. It could be a scholarship fund, a yearly supply of instruments and art supplies for low-income schools, a jump start for a community garden, and many other things!

What about each vehicles impact for my self?

Assuming a lifestyle cost of $20,000/yr and a savings of $20,000/yr with the interest rates above, you'd hit your retirement number in 22 years with SRIs and just 15 years with VTSMX. That is 7 more years of life committed to working for a boss or customer! 

Even here the SRI's portfolio would have to hold $300,000 more to sustain your $20,000/yr lifestyle! (Because SRIs safe withdrawal rate is 1.5% less due to the fees.) Imagine the wonderful things you could do for your self, your community, or causes near to you with 7 years free committed work and $300,000 extra in cash.

So my decision for which investment vehicle will 1) Have the greatest impact for my self? and 2) Have the greatest positive impact in the world or my community?

VTSMX! It wins by a long shot! 

Investing in a total stock market index fund will provide a greater opportunity to bring forth noteworthy positive change, and it will help reach financial freedom sooner.

That's my answer. Do you agree? Click "Comment" below if you want to join in on the discussion. It'd be fun to hear what you think!


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