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Socially responsible investing

(MoneyWatch) Whenever I hear the term "socially responsible investing," I'm typically being pitched some magical solution that is a combination of beating the market and creating social good. Also typical is that this socially responsible solution turns out to have high fees and the unlikelihood of performing well going forward. Garrett financial planner Tom Nowak's recent book, "Low Fee Socially Responsible Investing" offers some good advice without an agenda on the subject.

What constitutes being socially responsible will vary depending upon the investors' values. Some will want to avoid such "sin industries" as alcohol or tobacco. Some may want a faith-based definition such as companies supporting "Christian values," while others may want companies that are more socially tolerant. (Which means that some socially responsible funds will only invest in companies that offer benefits for same-sex couples, while some will only invest in companies that don't.) Or, as Nowak notes, companies screened to avoid partisan politics could be a definition. Though I'd certainly support that definition, Nowak has so far been unable to find such a fund. Here are some screens he suggests you choose from in developing a socially responsible portfolio that fits your values. You may have others.

  • Pollution
  • Diversity
  • Human rights
  • Labor relations
  • Executive pay
  • Alcohol
  • Animal testing
  • Weapons
  • Alcohol
  • Tobacco
  • Political views or support

Nowak defines "low fee" as costing no more than 0.5 percent annually. This fee must include both the fee for advice and the annual net management fee. I applaud Nowak on this definition of low fee, as I've heard others define it as two percentage points annually. He notes, however, that only about four percent of funds in the Socially Responsible Index (SRI) have fees of 0.5 percent or less.

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How will a socially responsible portfolio perform? Like any portfolio, performance relative to the broad stock market will be inversely related to costs. And luck is also involved. Before the stock market crash, I helped a Muslim client develop a portfolio of hundreds of stocks based partially upon religious criteria of avoiding certain industries. Two of those industries avoided included financials and insurance. That worked out quite well after the financial collapse.

My take

I admit that I own every sin company in anyone's socially responsible list of companies to avoid. But I also own every company in anyone's list of socially responsible companies to own. That's because between my total US and total international index funds, I own virtually every publicly held company on the planet.

In my view, there are many ways to be social responsible. Because it is more expensive to screen for socially acceptable investments, they tend to under-perform the broad index funds owning everything. I happen to agree with author and advisor Rick Ferri who recommends buying the whole market and using the extra returns to make a financial contribution to whatever cause you believe in.