Are Index Funds Bad for the Environment?
Remember when you found out the truth about Santa Claus and the Easter Bunny? Warning: What you are about to read might be equally devastating if you love index funds and care about the environment.
Many believe that indexing is infallible. If you go down the rabbit hole of personal finance online, you’ll most likely find yourself huddled around Bogleheads or in the middle of the FIRE Movement, kneeling at the altar of the almighty index fund.
Most financial advice gurus online revere indexing in an almost cult-like religious fashion.
Index What?
So what are index funds? They’re a passive way to buy the entire market, or segments of the market, at very little cost. Vanguard is at the center of the indexing universe and has fees that barely register.
Why have index funds become so popular? Index funds outperform most mutual funds, especially those with high expense ratios. In the world of 401ks and 529 plans, it’s almost impossible not to own an index fund. This all sounds great so far – until you pull back the curtain.
Here’s the bad news. Index funds don’t care about the environment or the betterment of society. When you buy an index fund, you’re supporting the climate-crisis-denying fossil fuel industry. You’re also supporting tobacco companies, weapons manufacturers, factory farms and other industries and companies that may not align with your values.
A Boatload of Money
Bloomberg news recently reported that the total market share of index funds is now at $4.7 trillion, surpassing active fund managers. Fossil Free Funds has written that the most popular index fund, the S&P 500, has 9.4% invested in the fossil fuel industry. Most of the other index funds have about the same percentage.
If you do the quick math, that means over $400 billion supports the air-polluting and planet-destroying industry. That is a boatload of money propping up a toxic industry!
Slave Trading Companies in the 19th Century
I’ve found that most people tend to compartmentalize their investing, separating it from the rest of their lives. You may tell yourself that you don’t care if your money is invested in fossil fuel companies as long as you get the highest return possible.
Are you really being entirely honest with yourself? If you don’t care, why not just throw bags of trash out the window when you’re driving? Why recycle at all? Why vote in the next election?
In the 19th century, you could buy shares of slave-trading companies on the Amsterdam, Paris and London stock exchanges. Do you think the people sitting around drinking tea on Abbey Road would have bought these shares if they actually understood the horrors the children in Africa faced as they were kidnapped from their families?
The Case For Sustainable Investing
I’ve heard some advisors say that instead of worrying about sustainable investing, you should just donate to an environmental cause you believe in. I think this is ridiculous. If the environment is important to you, why not do both?
The money you invest can and does have consequences. Every dollar spent bolstering the shares of Exxon Mobil and Chevron helps them spend more of their war chest on running misinformation campaigns and limiting government intervention.
Negative Externalities
One major problem with the fossil fuel energy companies is that they don’t properly price their external costs. An external cost occurs when consuming or producing a good has a negative effect on an unrelated third party.
Say you send your kid to a school located next to a gas burning plant that pollutes the air. Everyday your kid breaths in some of the pollution and as a consequence begins to suffer from asthma. Your kid doesn’t profit from the pollution but ends up with a debilitating lung disease. Any rational person would tell you that this isn’t fair and needs to be addressed by the government.
It’s hard to put a price on clean air and a habitable planet. If the government made fossil fuel companies pay the external costs associated with their products, then alternative energy would become dominant overnight. This is why these companies fight so hard against any regulation and spend handsomely on elections and lobbyists.
Divest/Invest
There is hope though! A major campaign is underway to change how people invest their money. The divest/invest movement, which began in 2014, has been wildly successful, resulting in over $11 trillion divested from fossil fuel companies.
Currently over 1,100 organizations and 59,000 individuals have pledged to divest. This includes financial advisors, endowments, pension funds and universities. Impact Fiduciary is proud to be a signatory of the divest/invest campaign.
Stranded Assets
Just last month, the University of California decided to divest its $13 billion endowment as well as its $70 billion pension fund. The University of California cited financial risks as the primary motivator of divestment. I, along with many other professionals, agree that fossil fuel companies makes lousy investments.
Source: www.fidelity.com. Past performance is no guarantee of future results.
The energy sector has been one of the worst places to invest your money over the past decade. Take a look at the chart above from Fidelity’s website. This shows the performance of the market versus the fossil fuel energy sector. The energy sector returned a paltry 2.78% while the market was up 182% over the same time period.
Where is your money?
Maybe you’ve invested $10k or $10 million in an index fund. At a minimum, you should be aware of where your money ends up. Wouldn’t it be nice to know that your money isn’t part of the problem?
According to Carbon Tracker, we’ll need to leave about $2.2 trillion worth of fossil fuels in the ground to not destroy the planet. Otherwise we can expect to see the planet reach the dangerous tipping point of warming by 1.5 degrees Celsius leading to apocalyptic outcomes. The time to take action is now, not 20 years from now.
You Can Still Index
The good news is that indexing can still be a core strategy. You just have to find the right type of funds. A growing number of index funds now have a responsible or sustainable mandate. There are also plenty of sustainable mutual funds and ETFs. Morningstar and Fossil Free Funds both offer sustainability and carbon sensitivity ratings.
So, should you still invest in your 401k if they don’t offer sustainable funds? Yes, you should still take advantage of your retirement plan in order to plan for your future. The reality is that you will most likely change jobs in the future and can then rollover the funds to a sustainable IRA.
Take Action
In the meantime you can take action by emailing your HR person to ask for sustainable fund options in your retirement plan. Consider banding together in a group effort with your fellow coworkers to assert maximum pressure on your company.
Don’t let perfect be the enemy of good. As a related example, I try to limit my fossil fuel consumption, but I still fly in airplanes and drive in gas cars. I’d love to walk or ride my bike everywhere but this just isn’t practical. The goal isn’t environmental perfection overnight, but to make changes where possible.
If sustainability and the environment are important to you, then I urge you to take action! Divest all of your investments where you have control. This includes old 401ks, IRAs and taxable brokerage accounts. Every dollar makes a difference.
The upside is that you can feel better about how you are investing while helping our society shift to a sustainable economy before it’s too late!
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Patrick Dinan, and all rights are reserved.