Over the past several years, you might have heard about socially responsible investing, sometimes known as “sustainable investing” or “ethical investing.” Probably the most common way to take part in this type of investing is through socially responsible mutual funds — but are these funds suitable for your overall financial goals?
Before you can answer that question, you need to become somewhat familiar with how these types of mutual funds operate. Basically, the managers of socially conscious funds seek to own companies that, in various ways, may promote such things as human rights and environmental and consumer protection. These managers also typically “screen out” those companies involved with the military, tobacco, alcohol and other industries involved with products or services that may be controversial.
So you may ask yourself, after these qualifications are imposed and screens are applied, can socially responsible mutual funds still find the right investments to earn a reasonable rate of return? And the answer is yes — the performance of many of these funds has been comparable to that of non-screened funds.
Furthermore, the performance of socially responsible funds can be tracked and measured against other funds with similar objectives. Socially responsible funds even have their own index — the Domini Social 400 Index. While this index is not managed, and you can’t invest directly in it, you will find it a useful tool should you decide to invest in socially responsible funds.
Yet, despite these factors, there is at least one potential drawback to investing in socially responsible mutual funds: lack of diversification. The problem isn’t so much that an individual socially responsible fund may not be properly diversified, although that could happen, given the necessity to screen out entire industries. The bigger issue is that the universe of socially responsible funds is much smaller than that of other funds, and socially responsible funds, by definition, resemble each other to a certain extent. Consequently, you may have a hard time achieving a diversified portfolio of socially responsible funds across different asset classes — small, mid-size and large companies, “value” stocks, international stocks, etc. — that is so important when investing.
Of course, diversification, by itself, cannot guarantee a profit or protect against a loss. However, the more asset classes you can diversify into, the better opportunity you have to help reduce the effects of volatility on your portfolio. This helps explain why socially responsible portfolios tend to have more volatile returns and are more susceptible to sharp downturns during bear markets than non-socially responsible mutual funds.
Before you invest in a socially conscious fund, or any mutual fund, for that matter, be sure to read the prospectus carefully, because it describes the fund’s investment objective, risks, charges and expenses. In the investment world, knowledge is power.
Ultimately, in evaluating socially responsible funds, you will have to decide just how much your sense of social responsibility will affect your investment choices. So take your time, evaluate all the factors involved, consider the alternatives — and make the decisions that are right for you.
• This article was written by Edward Jones for use by Ahwatukee Foothills Edward Jones Financial Advisor Kim DeVoss, CFP. Reach her at (480) 785-4751 or Kim.DeVoss@edwardjones.com.