I can understand why investors want to invest with their conscience.

Socially responsible investing can mean choosing companies that are sensitive to issues like the environment, consumers’ rights, human rights, and diversity. It can also mean choosing not to support companies whose business is tied to alcohol, gambling, military activities, or tobacco.

If you want to invest this way, or are already investing in socially responsible industries, you are not alone. One report estimated that in 2007 over $2.71 trillion was invested in a socially responsible manner.

The issue is not whether these causes are worthy. There is an obvious, nonmonetary benefit to taking a principled position and placing ethics above profits.

Viewed from an investing perspective, however, socially responsible investing can be problematic. Most socially responsible funds are “actively managed,” which means the fund manager attempts to beat a designated benchmark. The data on actively managed funds is dismal. Because of their high costs (the average expense ratio of these funds is 1.33 percent), only a very small percentage of them are able to equal (much less beat) their benchmark over time. For this reason, I recommend against investing in any actively managed fund—socially responsible or otherwise.

There is another way to be socially responsible in investing. Some low-cost index funds and exchange-traded funds (ETFs) screen for various social criteria. These funds have low expense ratios and track designated indexes. Here are some of the better ones:

  • The Vanguard FTSE Social Index Fund (VFTSX) tracks the FTSE4Good US Select Index and screens for certain social and environmental criteria. It has a low expense ratio of 0.29 percent.
  • While the TIAA-CREF Institutional Social Choice Equity Retail Fund (TICRX) is not technically an index fund, it screens the Russell 3000 and selects those stocks that meet its social criteria. It has a low expense ratio of 0.38 percent.
  • The iShares Select Social Index Fund (KLD) tracks the performance of the MSCI USA ESG Select Index, while the iShares KLD 400 Social Index Fund (DSI) invests in companies in the KLD 400 Social Index. Both have an expense ratio of 0.5 percent.

Those funds have a broad social agenda, but you can be narrower in your focus:

  • Energy and conservation: PowerShares WilderHill Clean Energy Portfolio (PBW)
  • Cleantech: PowerShares Cleantech Portfolio (PZD)
  • Progressive energy: PowerShares WilderHill Progressive Energy Portfolio (PUW)
  • Water industry: PowerShares Water Resources Portfolio (PHO)

Be a Socially Responsible AND a Smart Investor

If you decide to engage in socially responsible investing, remember not to abandon the basic principles of smart investing. You still need to focus on your asset allocation (the division of your portfolio between stocks and bonds), and your entire portfolio should consist only of globally diversified, low-cost, high-quality stock and bond index funds. I make specific fund recommendations in The Smartest Investment Book You’ll Ever Read. You can modify those recommendations to include some of the low-cost, socially responsible funds I have listed here.

Dan Solin is a Senior Vice-President of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You’ll Ever Read and The Smartest 401(k) Book You’ll Ever Read. His latest book is The Smartest Retirement Book You’ll Ever Read.

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