Conventional personal finance wisdom says to stash most of your savings in an index fund. An index fund tracks a stock market index like the S&P 500, so its performance is tied to a diverse set of stocks that, taken together over the long-term, provide a reliable return. But many people are defying this wisdom by investing their money in ways that reflect their values.
This type of investing is often called impact investing. And it's becoming more popular.
The Forum for Sustainable and Responsible Investment has tracked the market value of these funds since 1995. The value of a socially responsible investment fund, or SRI, has increased from $8.7 trillion at the start of 2016 to $12 trillion at the start of 2018.
People are more likely today to want to know where their money is going when they invest it, said Bill Brancaccio, certified financial planner and co-founder of Rightirement Wealth Partners in New York. They want to make sure it's not going to companies whose values they disagree with. But does this type of investing pay off?
How it works
The most common way to take part in SRI is to invest in mutual funds that consider how a company measures up against certain values, in addition to financial performance. In the investing world, these criteria fall into three main categories: environmental, social and corporate governance (ESG).
- Environmental considerations can include whether a company's business practices are environmentally sustainable and whether it's prepared for climate change, Brancaccio said.
- Social criteria include the diversity of the workforce and how business practices impact human rights.
- Corporate governance measures factors like the diversity of the board and the level of executive compensation.
The giant investment research firm Morningstar now scores companies on ESG factors alongside business performance. The majority of publicly traded companies now report out these measures, Brancaccio said. While it's possible for individual investors to track these factors and pick stocks on their own, investing in a mutual fund is probably easier and less risky.
"If you're using one of these mutual funds to do ESG investing, you know the companies inside are meeting the standards," Brancaccio said.
Does SRI pay off?
Investing this way might feel good, but nobody invests to feel good. They do it to make money.
So how do SRI funds stack up against the S&P 500 in financial performance?
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Many popular SRI funds hold up fairly well when compared against the S&P 500. Brancaccio said one reason is that companies that adhere to ESG principles are less likely to be involved incidents that might hurt their stock price, like discrimination scandals or environmental disasters.
"I would say in the early years of ESG or socially responsible investing, it was thought you would be giving up performance," he said. "I think today that's not the case because when you're investing in this style you're also doing some risk mitigation."
Unlike an index fund, which relies on an algorithm to manage its investments, many SRI funds are actively managed and rely on investment professionals to pick stocks. This comes the cost of higher expense ratios, total percentage of a fund that goes toward administrative and related expenses. (Not sure how to start investing? Read our guide.)
Take the Vanguard S&P 500 ETF, an index fund that tracks the S&P 500. One reason financial advisers love index funds is their low cost. The Vanguard fund is no exception, with an expense ratio of 0.03% In contrast, the Calvert US Large Cap Core Responsible Index Fund, a popular SRI fund, has an expense ratio of 0.24%.
The peace of mind of knowing their money is invested in companies that reflect their values might be worth the cost for some investors. For others, the extra expenses might be a turnoff. In any case, Brancaccio suggested doing research and speaking with a financial professional before deciding how to direct your investments.
Disclosure: Policygenius’ editorial content is not written by a financial professional. It’s intended for informational purposes and should not be considered legal or financial advice. Please consult a lawyer for legal advice.
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