Is a Million Bucks Enough to Retire?

Is a Million Bucks Enough to Retire?

By Tim Maurer

“Wow, those guys must be millionaires!” I can recall uttering those words as a child, driving by the nicest house in our neighborhood—you know, the one with four garages filled with cars from Europe.

The innocent presumption, of course, was that our neighbor’s visible affluence was an expression of apparent financial independence, and that $1 million would certainly be enough to qualify as “enough.”

Now, as an adult—and especially as a financial planner—I’m more aware of a few million-dollar realities:

1.  Visible affluence doesn’t necessarily equate to actual wealth. Thomas Stanley and William Danko, in their fascinating behavioral finance book, The Millionaire Next Door, surprised many of us with their research suggesting that visible affluence may actually be a sign of lesser net worth, with the average American millionaire exhibiting surprisingly few outward displays of wealth. Big hat, no cattle.

2. A million dollars ain’t what it used to be. In 1984, a million bucks would have felt like about $2.4 million in today’s dollars. But while it’s quite possible that our neighbors were genuinely wealthy—financially independent, even—I doubt they had just barely crossed the seven-digit threshold, comfortably maintaining their apparent standard of living. To do so comfortably would likely take more than a million, even in the ’80s.

3.  Wealth is one of the most relative, misused terms in the world.  Relatively speaking, if you’re reading this article, you’re already among the world’s most wealthy, simply because you have a device capable of reading it. Most of the world’s inhabitants don’t have a car, much less two. But even among those blessed to have enough money to require help managing it, I have clients who are comfortably retired on half a million and millionaires who need to quadruple their nest egg in order to retire with their current standard of living.

The teacher couple, trained by reality to live frugally most of their lives, don’t even dip into their $400,000 retirement nest egg or their $250,000 home equity because they have two pensions and Social Security that more than covers their income needs. Their retirement savings is just a bonus.

But the lawyer couple, trained by reality to live a more visibly wealthy existence, isn’t even close to retiring with their million-dollar retirement savings. In order to be comfortable, they’ll need to have at least $4 million.

A million bucks, then, may be more than enough for some and woefully insufficient for others.

A Simple Retirement Stress Test

A simple way to conduct a retirement stress test is to apply some elementary school math:

Expected Annual Pension Income

+ Expected Annual Social Security

+ Retirement Savings x .04 (4% withdrawal rate)

= Total Expected Annual Income

If your total expected annual income is more than your expected income needs, you passed the retirement stress test. If you didn’t, you’ve got more work to do. While your catch-up method will be based on your specific situation, there are really only two basic ways to improve your retirement readiness:

1. Increase your retirement income. As little as some want to hear it, working longer has a really powerful impact because you may be able to strengthen each of the three legs of the retirement stool—or at least two of them, if you don’t have a pension.

2. Decrease your retirement expenses. No one wants to retire and then live like a pauper, so decreasing spending is typically even more unpopular than working longer, but it need not be. If you’re willing to alter your geography and go on an adventure, moving from an area with a higher cost of living to a lower one can transform a seemingly hopeless scenario into one that is more than comfortable. This is especially true when you’re able to buy a comparable house for less and add the proceeds to your retirement nest egg. 


The million-dollar retirement goal gets a lot of attention. Remember, though, that personal finance is more personal than it is finance. Seeing one’s nest egg add another decimal place on the calculator may satisfy an emotional need, but there’s really no magic to it. A million is more than enough for some while lacking for others. The better question: What number works for you?

This commentary originally appeared June 18 on

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2018, The BAM ALLIANCE

To read the original article, click here.

The Scarcity Fallacy: Is Less Really More?

The Scarcity Fallacy: Is Less Really More?

By Tim Maurer

Having the privilege of walking through life with people vocationally, aiding in the acquisition, maintenance and dispossession of earthly resources as a financial advisor, I’m burdened with a heightened sense of the battling spirits of scarcity and abundance.

The dehumanizing poverty that torments the Majority World screams that resources—here and now—are scarce. Remembering when I handed a bowl of vitamin-charged oatmeal to a boy who lives and breathes in La Chureca, the Nicaraguan squatter town subsisting off of Managua’s trash, I occasionally twinge at my willingness to pay $5 for a cup of premium Central American coffee. That expenditure could buy a week’s worth of mush, keeping children of the dump alive.

How could I not consume less?

And share more?

Living with less has practical benefits, too. There’s less to clutter, less to maintain, less to depreciate, less to heat and cool, less to insure, less to worry about, less to carry.

Less to burden.

There are two whopping problems, however, with the scarcity doctrine and the pursuit of less:

First, like anorexia, a deep scarcity conviction cannot be satisfied.

One’s possessions can always be leaner.

One can always have less.

While the addiction of the day certainly leans toward the acquisition of more, we can also fall unhealthily in love with having less.

Interestingly, though, many of the people addicted to accumulation do so because they too are stricken by a belief in scarcity. The outgrowth of their worldview is to horde instead of dispossess, but the root is the same.

The biggest problem with the scarcity mindset, however, is that it is based in falsehood. While certainly not all, most of the resources that we use to build and buy goods and services are renewable or replaceable.

This is especially true of the commodity with which we interact most—money. Despite the “get mine” mentality, the battle for U.S. dollars is not a zero-sum game. For better and worse, they keep printing the stuff.

In the short term, those who make life a cash-grabbing exercise may find temporal rewards, but in the long term, dollars eventually shift away from those not adding value to those who do.

Minimalism and the pursuit of less is a means, not an end.

Satisfaction. Fulfillment. Contentment. Enough. These are worthy, if not elusive, ends.

We miss the mark to presume that contentment will be found through either the path of less or more, scarcity or abundance. Indeed, it may have little to do with either.

If you enjoyed this post, please let me know on Twitter @TimMaurer.

This commentary originally appeared May 13 on

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2018, The BAM ALLIANCE

To read the original article, click here.

Don’t Exclude Emerging Markets

Don’t Exclude Emerging Markets

By Larry Swedroe

Thirty years ago, emerging markets made up only about 1% of world equity market capitalization, and just 18% of global GDP. As such, the ability to invest in emerging markets was limited—the few funds available were high-cost, actively managed funds.

Today the world looks very different. Emerging markets represent about 13% of global equity capitalization, and more than half of global GDP. In addition, the cost of obtaining exposure to emerging markets has decreased considerably. The expense ratio of Vanguard’s Emerging Markets Stock Index Fund Admiral Shares (VEMAX), for example, is just 0.14%.

Two Common Mistakes       

Yet despite emerging market stocks representing about one-eighth of global equity market capitalization, the vast majority of investors has much smaller allocations to them, dramatically underweighting the asset class. This underweighting often is a result of two mistakes.

The first, and most prominent, is the well-known home country bias, which causes investors all around the globe to confuse familiar investments with safe investments. Unfortunately, it cannot be that every developed country is safer than the others. Compounding the problem, investors tend to believe not only that their home country a safer place to invest, but also that it will produce higher returns, defying the basic financial concept that risk and expected return are related.

The second mistake is that investors are subject to recency bias—allowing more recent returns to dominate their decision-making. From 2008 through 2017, the S&P 500 Index returned 8.5% per year, providing a total return of 126%. During the same period, the MSCI Emerging Markets Index returned just 2.0% a year, providing a total return of 22%. It managed to underperform the S&P 500 Index by 6.5 percentage points per year, and posted a total return underperformance gap of 104 percentage points.

Not only were investors earning much lower returns from emerging market stocks, they also were experiencing much greater volatility. While the annual standard deviation of the S&P 500 Index was about 15% per year, the MSCI Emerging Markets Index’s standard deviation was about 23% per year. Not exactly a great combination—lower returns with more than 50% greater volatility. What’s to like?

The illustration below depicts the difference between “convex” and “concave” investing behavior.

While investors know that buying high and selling low isn’t a good strategy, the research shows that individual investors tend to buy after periods of strong performance (when valuations are higher and expected returns are thus lower) and sell after periods of poor performance (when valuations are lower and expected returns are thus higher). Research has found this destructive behavior has led to investors underperforming the very funds in which they invest.

Furthermore, investors tend to have short memories. For example, it wasn’t long ago that investors were piling into emerging market equities due to their strong performance. For the five-year period 2003 through 2007, while the S&P 500 Index provided a total return of 83%, the MSCI Emerging Markets Index returned 391%. How quickly investors forget!

Drivers Of EM Risk & Return

Roberto Violi and Enrico Camerini contribute to the literature on emerging markets with the study “Emerging Market Portfolio Strategies, Investment Performance, Transaction Cost and Liquidity Risk.” The goal of their study, which was originally written in August 2016 but published on SSRN in March 2018, was to explore the prominent drivers of risk and return in emerging markets. They noted that emerging markets (EM) have the attractive qualities of high average returns and low correlation with developed markets (DM).

However, global markets have become more integrated, and correlations have risen. In addition, as EM have grown and become more investable, with implementation costs having fallen, the risk premium should also have come down. The question is whether the current empirical evidence would still suggest there is a significant benefit to including EM assets in a globally diversified portfolio.

Following is a summary of their findings:

  • Country factors still dominate cross-country valuations.
  • Investment barriers and other country factors are priced in.
  • High country-specific volatility can be diversified away.
  • EM assets still have higher risk than most DM assets, and, as a result, continue to command higher expected returns.
  • Factor-based investment strategies historically have worked in EM as well—value, momentum, quality and minimum volatility have all outperformed the market.
  • Institutional investors still appeared to underweight EM, though there is considerable dispersion across different institutions.
  • Lower transaction costs and increasing market liquidity have played an important role in fostering the expansion of the investor base in EM. However, transaction data—such as bid/ask spreads or market impact estimates—and estimated liquidity measures continue to show a wide gap vis-a-vis DM.
  • Index funds and ETFs allow investors to buy and sell less-liquid assets indirectly for low transaction costs. In addition, their management fees are typically low. Index funds and ETFs enable short-term investors to invest indirectly in illiquid stocks at low cost. Therefore, investors’ compensation for investing in illiquid EM stocks has been eroded over the years as index funds and ETFs have become more popular, resulting in a decline in the liquidity premium.
  • A combination of lower price-to-earnings (P/E) ratio and higher return on equity (ROE), along with higher expected economic growth rates, remains a major attraction for EM equity investment. (Note: As of March 19, 2018, Morningstar reports that the iShares MSCI Emerging Markets ETF (EEM) had a P/E of 12.1 and a price-to-book (P/B) ratio of 1.6. The comparable figures for the iShares Russell 3000 ETF (IWV) were 17.5 and 2.8, respectively.)
  • The risk/return profile of long-term investments in EM currencies has been historically quite attractive. Importantly, the return of EM currencies mostly comes from their high “carry,” as they typically have higher yields than DM currencies. (Note: The carry trade is well-documented in the literature, with the evidence demonstrating it has provided a persistent and pervasive premium across stocks, bonds, commodities and currencies. My book, “Your Complete Guide to Factor-Based Investing,” which I co-authored with Andrew Berkin, provides a detailed discussion on the carry trade.)

There are some other important points we need to cover.

Economic Growth Rates & Valuations

Many investors have been attracted to the fact that EM have experienced, and are forecasted to continue to experience, higher rates of economic growth than DM. However, academic research shows very little evidence of correlation between the rate of economic growth and equity returns. In fact, if anything, the evidence suggests a slightly negative relationship.

The logic is simple in that markets incorporate those higher expected rates of economic growth into prices—markets price not growth, but risk. Thus, a higher rate of growth, if accompanied by higher valuations, isn’t necessarily a prescription for higher expected returns.

However, as Violi and Camerini point out, while EM continue to have higher expected rates of economic growth, they also have lower valuations and higher ROE. Thus, while they are riskier, investors are compensated for that higher risk in the form of higher expected returns.

Is Active Management The Winning Strategy?

With EM being considered by so many as inefficient (or less efficient), it should not be a surprise that a majority of funds providing exposure to these markets is managed actively. Long-term performance results for actively managed funds, however, reveal a different story about their supposed advantage in this space.

To give us 15 years of performance data (as of March 20, 2018), using Morningstar’s rankings, which contain survivorship bias (only surviving funds are in the data), I’ll examine the rankings of three of the Dimensional Fund Advisors (DFA) EM funds: its Emerging Markets Portfolio (DFEMX), its Emerging Markets Value Portfolio (DFEVX) and its Emerging Markets Small Portfolio (DEMSX). (Full disclosure: My firm, Buckingham Strategic Wealth, recommends DFA funds in constructing client portfolios.)

Even with the survivorship bias in the data (and at 15 years, it can be quite large), each of the three funds outperformed the vast majority of actively managed funds, as their respective rankings were in the 35th, ninth and third percentiles.

Highlighting the importance of survivorship bias is that the year-end 2017 SPIVA scorecard found that just 55% of active funds survived the full 15-year period it examined. If we adjust the Morningstar rankings on the three DFA funds to account for that degree of survivorship bias, their rankings improve to the 19th, fifth and second percentiles. And that’s on a pretax basis.

Because the greatest cost of active management is often taxes, for taxable investors, the data presents an even more compelling case that, in EM, active management is a loser’s game.

The performance rankings of the three DFA funds suggest that EM are not as inefficient as active managers would have you believe. However, there’s another explanation for the poor performance of active managers.

As Violi and Camerini explain: “The cost of trading is structurally higher in EM. In particular, comparing transaction costs in emerging markets to more developed markets, it turns out that total costs are 95% larger relative to all other markets and over double those observed in the US…. Much of this difference lies in implicit trading costs, where EM costs are over 1.5 times those of more developed markets, but explicit costs also are a factor, being 70% higher in the EM space.”

They found that, while the total costs of a passive strategy are about 50-60 basis points, the costs of active strategies are, on average, almost triple that, at about 1.7%. That’s a high hurdle to overcome in the effort to achieve alpha.

Style Premia

As noted, Violi and Camerini found that factor-based investment strategies have historically worked in EM. We can see this in live funds by examining the returns of the same three DFA funds. The longest period we have for the three begins May 1998. From May 1998 through February 2018, the MSCI Emerging Markets Index returned 8.1%, while DFA data show that DFEMX returned 8.8%, DFEVX returned 11.2% and DEMSX returned 11.8%.

Rising Correlations

While Violi and Camerini noted that global markets have become more integrated and, thus, the correlation between EM and DM have risen, EM are still not fully integrated into world capital markets. Therefore, emerging markets should still be viewed as a distinct asset class.

We don’t need any more evidence that performances can be dramatically different than to look at the returns from 2003 through 2007, when EM dramatically outperformed (the S&P 500 Index underperformed the MSCI Emerging Markets Index by 303 percentage points in terms of total return), and from 2008 through 2017, when EM dramatically underperformed (the MSCI Emerging Markets Index underperformed the S&P 500 Index by 104 percentage points in terms of total return).

If the world market was fully integrated, we would not expect to see such dramatic differences. Clearly, there are still significant diversification benefits to be had.

The Case For Global Diversification

Diversification rightly has been called the only free lunch in investing. A portfolio of global equity markets should be expected to produce a superior risk-adjusted return to any one country or region held in isolation. However, the benefits of global diversification came under attack as a result of the financial crisis of 2008, when all risky assets suffered sharp price drops as their correlations rose toward 1.

When that happened, many investors surmised that global diversification doesn’t work because it fails when its benefits are needed most. That is wrong on two fronts. First, the most critical lesson investors should have learned is that, because correlations of risky assets tend to rise toward 1 during systemic global crises, their portfolios should be sufficiently allocated to the safest bond investments (investments such as U.S. Treasury bonds, FDIC-insured CDs and AAA/AA-rated municipal bonds). The overall portfolio should reflect one’s ability, willingness and need to take risk.

At the time they’re needed most (during systemic financial crises), the correlations of the safest bonds to stocks, which average about zero over the long term, tend to turn sharply negative. They benefit not only from flights to safety but from flights to liquidity.

The second lesson many investors failed to understand is that, while international diversification doesn’t necessarily work in the short term, it does work eventually. This point was the focus of a paper by Clifford Asness, Roni Israelov and John Liew, “International Diversification Works (Eventually),” which appeared in the May/June 2011 edition of the CFA Institute’s Financial Analysts Journal.

The authors explained that those who focus on the fact that globally diversified portfolios don’t protect investors from short systematic crashes miss the greater point that investors whose planning horizon is long term (and it should be, or they shouldn’t be invested in stocks to begin with) should care more about long, drawn-out bear markets, which can be significantly more damaging to their wealth.

Long-Term Game

In their study of 22 DM countries during the period 1950 through 2008, the authors examined the benefit of diversification over long-term holding periods. They found, over the long run, markets don’t exhibit the same tendency to suffer or crash together. As a result, investors should not allow short-term failures to blind them to long-term benefits.

To demonstrate this point, the authors broke down returns into two components: (1) those due to multiple expansions (or contractions); and (2) those due to economic performance.

Asness, Israelov and Liew found that, while short-term stock returns tend to be dominated by the first component, long-term stock returns tend to be dominated by the second.

They explained that these results “are consistent with the idea that a sharp decrease in investors’ risk appetite (i.e., a panic) can explain markets crashing at the same time. However, these risk aversion shocks seem to be a short-lived phenomenon. Over the long run, economic performance drives returns.”

They further showed that “countries exhibit significant idiosyncratic variation in long-run economic performance. Thus, country specific (not global) long-run economic performance is the most important determinant of long-run returns.”

For example, in terms of worst-case performances, the authors found that, at a one-month holding period, there was very little difference in performance between home-country portfolios and global portfolios. However, as the horizon lengthened, the gap widened. The worst cases for global portfolios are significantly better (the losses are much smaller) than the worst cases for local portfolios. The longer the horizon, the wider the gap favoring the global portfolios becomes.

Demonstrating the point that long-term returns are more about a country’s economic performance and that long-term economic performance is quite variable across countries, the authors found that “country specific economic performance dominates long-term performance, going from explaining about 1% of quarterly returns to 39% of 15-year returns and rising quite linearly in time.”


We live in a world where there are no accurate crystal balls. Thus, the prudent strategy is to build a globally diversified portfolio. And that includes a significant allocation to EM, with its global market cap weighting (about one-eighth of total equities) being a good starting point.

Unfortunately, that’s just the necessary condition for success. The sufficient condition for success is to possess the discipline to stay the course, ignoring not only the clarion cries from those who think their crystal balls are reliable, but also the cries from your own stomach to GET ME OUT! As Warren Buffett explained, “The most important quality for an investor is temperament, not intellect.”

To help you stay disciplined and avoid the consequences of the dreaded investment disease known as recency, I offer the following suggestion. Whenever you are tempted to abandon your well-thought-out investment plan because of poor recent performance, ask yourself this question: Having originally purchased and owned this asset when valuations were higher and expected returns were lower, does it make sense to now sell the same asset when valuations are currently much lower and expected returns are now much higher?

The answer should be obvious. And if that’s not sufficient, remember Buffett’s advice to never engage in market timing, but if you cannot resist the temptation, then buy when others panic and sell when others are greedy.

This commentary originally appeared April 16 on

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2018, The BAM ALLIANCE

To read the original article, click here.

The ‘Price’ of Socially Responsible Investing

The ‘Price’ of Socially Responsible Investing

By Larry Swedroe

Socially responsible investing (SRI) has been referred to as “double bottom line” investing, meaning investments should not only be profitable, they should meet personal standards.

For instance, some investors don’t want their money to support companies that sell tobacco products, alcoholic beverages or weapons, or that rely on animal testing in their research and development efforts.

Other investors may also be concerned about environmental, social and governance (ESG) or religious issues. SRI and the broader category of ESG encompass many personal beliefs and don’t reflect just one set of values.

SRI has gained significant traction in portfolio management in recent years. In 2016, SRI funds managed approximately $9 trillion in assets from an overall investment pool of $40 trillion in the United States, according to data from US SIF.

While SRI and ESG investing continue to gain in popularity, economic theory suggests that if a large enough proportion of investors choose to avoid “sin” businesses, their share prices will be depressed.

In equilibrium, the screening out of certain assets based on investors’ taste should lead to a return premium on the screened assets. Screened assets will have a higher cost of capital because they will trade at a lower price-to-earnings (P/E) ratio. Thus, they provide investors with higher forward-looking return expectations (which some investors may view as compensation for the emotional “cost” of exposure to offensive companies).

Demand For SRI

Rocco Ciciretti, Ambrogio Dalo and Lammertjan Dam contribute to the SRI literature with their June 2017 study, “The Price of Taste for Socially Responsible Investment.” They begin by observing that the demand for SRI can be explained by two different effects: the favorable risk characteristics of “responsible” assets and investors’ taste for such assets.

They write: “The risk effect arises when responsible assets exhibit financial risk characteristics that appeal to investors. For example, SRI might reduce exposure to stakeholder risk, such as potential consumer boycotts or environmental scandals, that have an impact on stock returns.”

Their explanation for the taste effect “is that certain investors do not want to facilitate ‘irresponsible’ corporate conduct and construct their portfolios accordingly.”

The authors then focus their paper on the taste effect’s contribution in risk-adjusted returns—in other words, the “the price of taste.”

To determine the price of taste, Ciciretti, Dalo and Dam built a model that accounts for exposure to the market beta, size, value and momentum factors, as well as incorporating an SRI score based on six dimensions: business behavior, corporate governance, community involvement, environment, human resources and human rights. Their study covers the period July 2005 through June 2014 and 1,000 firms (295 in the U.S., 512 in Europe and 193 in the Asia-Pacific region).

Following is a summary of their findings:

  • Overall, the average monthly excess return declines moving from the worst to the best SRI portfolio.
  • A strategy that buys the worst portfolio and sells the best portfolio yields an additional excess return of 7.2 percentage points on annual basis, and was statistically significant (t-stat of 4.0).
  • Composing portfolios with firms that have higher responsibility scores does not increase the overall portfolio market beta, value or momentum exposures. However, the size and corporate social responsibility (CSR) risk factor betas decrease moving from the worst to the best SRI portfolios—companies become larger and SRI scores become better (decreasing stakeholder risk exposure for firms with higher social responsibility scores).
  • There’s a significant and negative relationship between social responsibility scores and risk-adjusted returns, with price of taste amounting to 4.8% annually for the representative responsible firm.

The authors concluded: “Both risk and taste play a role in explaining differences in returns between more and less responsible companies.”

They added that investors pay a price in terms of lower returns due to their preference for SRI, and also that the premium related to the responsibility score, the price of taste, is negative and significant. These findings are consistent with prior research.

Supporting Evidence

One of the largest SRI investors is Norway’s $870 billion Government Pension Fund, the country’s sovereign wealth fund. The fund divests companies from its investment portfolio based on two types of exclusions.

The first is product-based exclusions, which include weapons, thermal coal, and tobacco producers and suppliers. The second is conduct-based exclusions, which involve companies with a track record of human rights violations, severe environmental damage and corruption.

According to Norges Bank Investment Management, which manages the fund’s assets, the fund has missed out on 1.1 percentage points of additional gain due to the exclusion of stocks on ethical grounds over the past 11 years. The following list describes the impact of some of the fund’s specific product-based exclusions relative to the benchmark, the FTSE Global All Cap Index:

  • The exclusion of tobacco companies and weapon manufacturers reduced the return of the equity portfolio by 1.9 percentage points.
  • Divesting from tobacco manufacturers reduced the portfolio’s return by 1.16 percentage points.
  • Avoiding weapons-makers decreased the portfolio’s return by 0.75 percentage points.
  • Conduct-based exclusions of mining companies have had a minor effect on the portfolio’s return versus the benchmark index.

Findings such as these have led to the development of an investment strategy that focuses on the violation of social norms in the form of “vice investing” or “sin investing.”

This strategy creates a portfolio of firms from industries that are typically screened out by SRI funds, pension funds and investment managers. Vice investors focus primarily on the “sin triumvirate”: tobacco, alcohol and gaming (gambling) stocks. The historical evidence on the performance of these stocks supports the theory.

Sin’s ‘Price’

Greg Richey contributed to the literature on the “price of sin” with his January 2017 paper, “Fewer Reasons to Sin: A Five-Factor Investigation of Vice Stocks.”

His study covered the period October 1996 to October 2016. Richey employed the single-factor CAPM model (market beta), the Fama-French three-factor model (which added size and value), the Carhart four-factor model (adding momentum) and the new Fama-French five-factor model (market beta, size, value, profitability and investment) to investigate whether a portfolio of vice stocks outperforms the S&P 500, a benchmark to approximate the market portfolio, on a risk-adjusted basis.

His dataset included 61 corporations from vice-related industries. Following is a summary of his findings:

  • For the period October 1996 through October 2016, the S&P 500 returned 7.8% per year. The “Vice Fund” returned 11.5%.
  • The alpha, or abnormal risk-adjusted return, shows a positively significant coefficient in the CAPM, Fama-French three-factor and Carhart four-factor models.
  • All models, including the Fama-French five-factor model, indicate that the Vice Fund portfolio beta is between 0.59 and 0.74, in turn indicating that the vice portfolio exhibited less market risk or volatility than the S&P 500 Index, which has a beta of 1, over the sample period. This reinforces the defensive nature of sin portfolios. With the three-factor and four-factor models, the vice portfolio has a statistically significant negative loading on the size factor (-0.17 and -0.18, respectively) and a statistically positive loading on the value factor (0.15 and 0.21, respectively), indicating that these exposures help explain returns. With the four-factor model, the Vice Fund loaded about 0.11 on momentum, and it was statistically significant. However, with the five-factor model, the negative size loading shrinks to just -0.05 and the value loading turns slightly negative, also at -0.05, and both are statistically significant. In the five-factor model, the vice portfolio loads strongly on both profitability (0.51) and investment (0.48). All of the figures are significant at the 1% level.
  • The annual alphas on the CAPM, three-factor and four-factor models were 2.9%, 2.8% and 2.5%, respectively. And all were significant at the 1% level. These findings suggest that vice stocks outperform on a risk-adjusted basis. However, in the five-factor model, the alpha virtually disappears, falling to just 0.1% per year. This result helps explain the performance of vice stocks relative to the market portfolio that previous models fail to capture. The r-squared figures ranged from about 0.5 to about 0.6. Richey concluded that the higher returns to vice stocks occurred because they are more profitable and less wasteful with investments than the average corporation.

Harrison Hong and Marcin Kacperczyk, authors of the study “The Price of Sin: The Effects of Social Norms on Markets,” published in the July 2009 issue of the Journal of Financial Economics, found that for the period 1965 through 2006, a U.S. portfolio long on sin stocks and short their comparables had a return of 0.29% per month after adjusting for the four-factor model. As out-of-sample support, sin stocks in seven large European markets and Canada outperformed similar stocks by about 2.5% a year.

They concluded that the abnormal risk-adjusted returns of vice stocks are due to neglect by institutional investors, who lean on the side of SRI. In a recent article, I provided a more detailed analysis of this study and a risk-based analysis of socially responsible funds.

Additional Evidence

As further evidence that avoiding sin stocks comes at a price, Elroy Dimson, Paul Marsh and Mike Staunton found that, when using their own industry indexes that covered the 115-year period 1900 through 2014, tobacco firms beat the overall equity market by an annualized 4.5% in the U.S. and by 2.6% in the U.K. (over the slightly shorter 85-year period 1920 through 2014). Their study was published in the 2015 Credit Suisse Global Investment Handbook.

They also examined the impact of screening out countries based on their degree of corruption. Countries were evaluated using the Worldwide Governance Indicators from a 2010 World Bank policy research working paper from Daniel Kaufmann, Aart Kraay and Massimo Mastruzzi, “The Worldwide Governance Indicators: Methodology and Analytical Issues.” The indicators comprise annual scores on six broad dimensions of governance.

Dimson, Marsh and Staunton found 14 countries that posted a poor score, 12 that were acceptable, 12 that were good and 11 with excellent scores. Post-2000 returns for the last three groups were between 5.3% and 7.7%. In contrast, the markets with poor control of corruption had an average return of 11.0%.

Interestingly, realized returns were higher for equity investments in jurisdictions that were more likely to be characterized by corrupt behaviors. As the authors note, the time period is short and the result might just be a lucky outcome.

On the other hand, it’s also logical to consider that investors will price for corruption risk and demand a premium for taking it. But it may also be a result of the same exclusionary factors found with sin stocks (investors boycott countries with high corruption scores, driving prices down, raising expected returns).


There are many forms of SRI and ESG investing, and every investor has their own personal views. Thus, it’s no surprise that each SRI/ESG fund has its own fund construction methodology.

For example, consider the “gay benefits” issue. Some funds exclude companies like Walt Disney for having gay-friendly policies. On the other hand, the Meyers Pride Value Fund only invests in companies with partner employee benefits and policies that prohibit discrimination.

There are even funds designed for Catholics (Ave Maria Mutual Funds), Muslims (Amana Mutual Funds Trust), Presbyterians (New Covenant Funds) and Christians of all denominations (The Timothy Plan). Our capitalist system is great at responding to demand.

The preceding evidence suggests that investors who desire to express their views on ESG or religious issues may pay a price in the form of lower returns. The reason is that some screens, like those that eliminate sin stocks, lead to lower returns.

The bottom line is that if you are considering SRI/ESG as an investment strategy, you should carefully evaluate fund construction methodology before making any decisions. It may even be difficult to find a fund that exactly meets your own personal criteria. For investors with sufficiently large investable assets, there are asset managers that will build individually tailored SRI/ESG portfolios (that provide the added benefit of tax efficiency).

Finally, investors who are aware of the trade-off between wants (better returns versus expressing their beliefs) may still be willing to trade the utilitarian benefit of greater forward-looking return expectations for the expressive and emotional benefits of avoiding the stocks of shunned companies. An alternative is to invest without consideration for these issues and then donate any higher return directly to your most important causes.

To read the original article, click here.

This commentary originally appeared November 3 on

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