What You Need to Know About Socially Responsible Investing

There may be trade-offs with this niche category of mutual funds.


One interesting category created by the mutual fund industry that has grown over time is socially responsible investing (SRI). These funds won't invest in companies that pollute the environment, make addictive substances such as alcohol or tobacco, have bad corporate governance practices, or don't respect human rights. Essentially, they screen for profitable companies that make positive contributions to society. The number of SRI funds in the U.S. has grown to 250 with assets of $316.1 billion in 2010, up from 55 funds with $12 billion in assets in 1995, according to the Social Investment Forum.

Similarly, some funds are devoted to investing based on religious beliefs or other social causes. The Ave Maria funds follow the doctrines of the Catholic Church, while the Amana funds abide by Islamic principles. On the flip side, at least one fund—Vice Fund (symbol VICEX)—takes a different approach. It invests in companies that make things harmful for our health and society, such as casinos and makers of alcohol, cigarettes, and weapons.

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SRI funds follow worthy causes and may be great for some people. However, there are two things you should consider before buying one.

First, whenever you buy a fund that restricts what the manager can buy, you have to be willing to accept lower returns in exchange for the things that are important to you. This doesn't mean you'll automatically earn lower returns with an SRI fund, and I don't want to say you shouldn't invest in what you believe in. You just have to be prepared for the possibility of lower returns with an SRI fund than what you can get elsewhere.

For example, let's say a highly respected analyst recommends a stock that he thinks will double over the next year. If that stock doesn't meet the screens of an SRI fund, the manager can't buy that stock and may miss out on potentially higher returns.

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Some SRI funds have shown decent performance in certain periods, even with the restrictions. The Amana funds, for example, performed well during the 2008-2009 financial crisis because—under Islamic rules that prevent people from owning interest-bearing investments—the funds can't invest in banks. However, while the funds avoided the steep declines in bank stocks, they couldn't participate in the rebound after the government bailed out many banks.

The second thing to consider is whether the fund's definition of socially responsible meshes with your own beliefs. What is socially responsible to you may be different from the fund's definition. For example, maybe you're most concerned about the environment, but an SRI fund's screen might be more focused on diversity in the workplace. Just because the fund says it is socially responsible, it may not follow the same guidelines that you're looking for.

That's why it's important to read the prospectus to understand the fund's strategy and the manager's criteria for screening companies. Look for exactly what the fund can and can't buy.

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You might agree with the fund's mission, and feel better knowing you won't own shares of companies that operate nuclear power plants, or make weapons and other bad stuff. But you also have to be willing to accept a lower return in exchange for owning socially responsible investments.

I'll never be the one who tells you not to invest in what you believe in. That's a personal decision. However, before purchasing an SRI fund, you need to decide how much it might cost you.

Adam Bold is the founder of The Mutual Fund Store, which provides fee-only investment advice with locations coast-to-coast. He's also host of The Mutual Fund Show, a call-in radio program broadcast across the country. Bold is author of the book The Bold Truth about Investing (April 2009). Bold is Chief Investment Officer of The Mutual Fund Research Center, an SEC-registered investment adviser, which provides mutual fund and asset allocation recommendations, and research to stores in The Mutual Fund Store system.