In part 1 of this series, I discussed the concept of ESG investing from a secular standpoint and evaluated the screening of GuideStone Funds, the Southern Baptist Convention financial services arm. In part 2, I evaluated three more Christian providers of investment funds and discussed the dollar value of ESG investing. Here in part 3, I’ll try to put the big picture together.
The Conscience Issue
In the latter section of part 2, I explained how money from individual investors rarely shows up in the accounts of companies because companies raise capital when they sell shares, not when those shares are being traded around by others. This does leave two other issues for the conscience:
The first issue is increasing the demand signal, therefore increasing the stock price, of objectionable companies. If improving the stock price in and of itself is an issue, then in order to be consistent, we would need to avoid anything that improves such companies’ stock prices, especially purchasing any products from said company. Confession: In the past year, I have purchased Bounty paper towels, Charmin toilet paper, Head & Shoulders shampoo, Dawn laundry detergent, Oral-B toothbrush refills, and Vicks medicine.
But on my dog’s life, I will never buy another Gillette razor blade because of that ludicrous, effeminate, anti-masculinity woke ad during last year’s S****B***—really important football game!!
(Actually, I was already using an old school double-edge safety razor…you know, like a man. )
And yet despite the popular outrage from that ad, I didn’t see a single person announce a boycott of Procter & Gamble stock or products. I’m willing to bet literally no one divested from S&P 500 or U.S. total stock market index funds (all of which include P&G by default) because of that ad. But I have done more to improve Procter & Gamble by purchasing their non-Gillette products than I could ever hope by avoiding their stock. And I haven’t been screening drug companies before heading to the pharmacy to pick up perfectly ethical medications for my ailments. Consistency is difficult.
The second issue is receiving profit from objectionable companies and operations. In my view, this also hangs on how mutual fund or ETF investment isn’t funding the company that is producing the profits. The profits are going to be produced regardless of one’s own purchase of stock on the secondary market. Moreover, with many of these companies, the operations that cause them to be screened out are a small portion of the overall operation. I say take the profits and put them where they do the most good. Even here, an absolutist stance is not possible. There’s no such thing as a bank that morally screens its customers the way a Christian mutual fund may screen its investments. The moment we receive interest payments from a savings account, we can’t be absolutist.
That said, you might not find these arguments convincing, and that’s okay. As with many things when it comes to Christian liberty, it’s a heart issue. If this burdens your heart, I have no right to impede you in any way. Later in this post, I’ll provide some sample portfolios that you may find helpful.
The China Problem
Treasonous propaganda—encouraging American investors to bet on China’s success and America’s failure by pouring money into a dictatorial communist regime. https://t.co/tAMS6FV6ID
— Allie Beth Stuckey (@conservmillen) November 30, 2020
I’ll bite in long form sometime later @ThingsAboveBlog; I’ve been sitting on thoughts on this for months.
The strategist’s job is to provide investment advice, not moral advice. You don’t have to follow the former. https://t.co/U3JhO7Xqpy
— Garrett O’Hara 🍥 (@mokaThought) November 30, 2020
China is an area where I feel like we have some untested waters. The human rights problems in China are enormous and manifold, and that alone may be enough to keep many investors away. On top of this, we also have an enormous political problem with respect to transparency and rule of law. Here in the United States, publicly traded companies have strict transparency requirements with the SEC. That’s not to say the occasional Enron doesn’t happen, but the risk of one is arguably far smaller. Normally, we would say that these risks are already priced in because all market participants know about them, but my own estimation of these risks is almost certainly greater than the overall market’s. Therefore, I avoid funds that hold Chinese stocks and bonds. This isn’t too difficult from an index fund investing standpoint if one learns to read the information about where funds invest.
But if we’re going to take an absolutist stance and be consistent, that is remarkably difficult. Inexpensive Chinese manufactured goods are all over our homes and our retail stores as is. And as Vanguard founder John Bogle pointed out, even holding an S&P 500 index fund gives the investor international exposure because these companies do business internationally. Bogle went so far as to recommend avoiding international stocks and just holding a U.S. stock index fund. There probably isn’t such a thing as an “American business that doesn’t do any business in China screen” for any mutual fund or ETF. You may be stuck with a “best-effort” stance if you wish to take one.
International stocks are most basically divided into two categories: developed markets and emerging markets. These are characterizations of the nations’ markets, not their economies. Universally, China is considered an emerging market despite having the world’s second-largest economy. If you wish to avoid China, limiting one’s international stocks to developed markets funds will do the trick. One can supplement a developed markets fund with an emerging markets fund such as EMXC (iShares Emerging Markets ex-China ETF) and FRDM (Alpha Architect Freedom 100 ETF) to gain exposure to these markets without including China. I happen to hold both of these ETFs.
I’m going to skip individual stock picking, as I think most of us already know of that option, and point out two more alternatives that are arguably less well-known.
One alternative is a form of individual stock investing called direct indexing. This is accomplished by pulling up a list of stocks in an index, deleting the ones you don’t want, and then investing in the rest proportionally. (This is basically what GuideStone’s Equity Index Fund tries to do, albeit inconsistently with their screening claims as I explained in part 1.) You’ve then created your very own “socially responsible index fund.” As you can imagine, this is going to be really time-consuming. However, this has been made much easier to accomplish as of late now that brokerages like Fidelity and Schwab offer commission-free trades and fractional share trading. If the calculation requires you to purchase 0.4 shares, that can now actually be done.
The second alternative is buying normal index funds and then proportionally “short selling” the stocks that you don’t want, thereby neutralizing their effect. Short selling is the act of selling a security that you do not own. Normal short selling is basically a bet that a security’s price will go down. For example, hedge fund manager George Soros is famous in the financial industry for having made more than a billion dollars in one day by short selling the British pound. When Soros was right and the pound fell, Soros made more than one billion U.S. dollars in a day. Proportionally short selling a stock you don’t want basically means you gain or lose the exact opposite amount that the stock gains or loses in your mutual funds or ETFs.
I think the risks of miscalculation and behavioral error are far too great for these alternatives to be worth pursuing.
Establishing a Plan
Now suppose that you do wish to tailor your investments in an ESG direction or otherwise avoid certain undesirables (e.g. China). That might be difficult enough if you’ve never dug into fund literature. And if you’re in any kind of employer-sponsored retirement account like a 401(k) or 403(b), your fund choices may be limited to a much smaller list than the “universe” of ETFs and mutual funds available outside of your plan. The same might also go with 529 plans for kids’ education savings. My own kids’ 529 college savings accounts unsurprisingly have secular ESG products but no Christian products.
There isn’t enough space in a reasonably-sized blog post to cover everything, but I’ll note some things to consider.
Understand Asset Allocation
Asset allocation at its most basic level is the ratio of stocks, bonds, and cash in your portfolio. I touched upon this a couple of years ago in this post. Since that time, I’ve personally drifted from “age in bonds” (e.g. 65% stocks, 35% bonds based on being 35 years old) to a 70% stocks, 30% bonds position based on my own risk tolerance.
Once you have determined the ideal ratio for you, you’ll need to account for this across all of your accounts. What matters is not holding the same ratio in each individual account but holding that ratio in sum. For example, you could choose to hold stock funds in one account and bond funds in another account. If they add up to your ideal ratio, you’re well on your way.
Watch Out For Fees
Does less than one percent really make a difference? Using a compound interest calculator, assume $500 invested monthly over a 30 year time period compounded monthly. The final value with an 8% annual interest rate is $745,179.72. Now let’s take GuideStone’s average expense ratio, 0.92%, and subtract it from our compound interest calculator. A growth rate of 7.08% yields a final value of $619,702.21. Slightly less than one percent in fees made a difference of $125,477.51. If Albert Einstein was correct in calling compound interest the eighth wonder of the world, the impact of compounding fees is wonderfully undesirable. You may well consider this a stewardship issue.
Know Your Funds’ Underlying Investments
I used to sit down and try to read an entire fund prospectus and come away feeling smarter but not really understanding what I read. You’re better off starting with the fund’s “fact sheet” where all of the basic information is spelled out plainly. You should learn whether the fund is actively managed or index-based. If it’s index-based, understand the index that it’s based on. If you need to dig further, you can use various online tools. Inspire Insight will do a decent job screening for underlying investments from a social responsibility standpoint, but it doesn’t cover all funds and securities in existence. You may wish to pull up a periodic report from a fund’s website where you can find the “schedule of investments” which spells out every holding.
Stay the Course
Don’t try to time the market. Make a plan for your asset allocation, ignore the noise from CNBC, and let the investment work for you. You might even limit yourself to looking only once a year and rebalancing back to your asset allocation.
And I must emphasize sample, not crafted for your exact situation. Given that I have four different retirement accounts in our household, I cannot use any one of these on its own. However, with a little spreadsheet work, you can craft a portfolio that works for you.
And do let me know if you have questions or thoughts. Even better, stop by the Bogleheads forum where there are plenty of people who are smarter than I and from whom I’ve learned much. You’ll find me around there with the handle ‘mokaThought.’
Click here to view the sample portfolios.
Overly specific SEC disclosure: I am not a financial professional. My degrees are in political science and New Testament, not finance. My professional license is a Class A commercial driver license, not a FINRA license, CFP, or CFA. It is probably illegal for me to accept any payment for advice, and I wouldn’t do it anyway if it were legal. You alone are responsible for your own investment decisions. I am long TSP G Fund, TSP F Fund, a 401(k) S&P 500 fund, a 401(k) S&P 400 fund, a 401(k) Russell 2000 fund, VTI, IDEV, EMXC, FRDM, VCIT, QLTA, VSTSX, VDIPX.
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