Is Local Investing More Sustainable?
Many sustainably-minded investors adhere to the old slogan ”Think Globally, Act Locally” and try to localize their investments. They see this as a way to support smaller businesses with good sustainability practices and to strengthen their communities. They don’t want to put their money into large corporations, which they perceive as “faceless” and unresponsive and they don’t want to pay fees to the financial industry. These are understandable and even praiseworthy goals but is local investing actually more sustainable? I don’t believe that it is.
In this troubled world, many are seeking to cultivate their own gardens by localizing their investments. This movement takes the idea of buying local produce and patronizing local businesses a step farther by seeking to keep investor’s capital as local as their spending. The financial crisis of 2008-09 and recent market volatility have provided further impetus to this since local businesses are seen as potentially more stable. Michael Shuman - author of “Local Dollars, Local Sense” - is a leading proponent of localizing your investments. He and others have been guiding locally minded sustainable investors in creating local investment structures.
Who doesn’t want to see their community do well? Most of us want our friends and neighbors to prosper. There is no denying the satisfaction that many get from seeing their money help their local food co-op, organic farm or bookstore grow. It is hard to get the same feeling of satisfaction from your 0.0001% holding of Amazon, no matter how much money that investment has made.
But yet people who localize their investments are taking on a whole new set of risks, substantially narrowing their range of investment opportunities and replacing one set of moral and ethical dilemmas with another.
Local Investing May Be Sustainable but It Can Increase Your Financial Risk
It may seem paradoxical but putting your money into your neighbors’ businesses can be riskier than investing in the stock market. Two key issues to bear in mind when picking any investment are diversification and liquidity. A prudent investor holds a wide range of investments so that if any one investment goes wrong it won’t blow up their portfolio. Liquidity is important to ensure that investors have access to their cash when they need it.
A localized investment portfolio by its very nature holds fewer, geographically concentrated, investments. The individual investor would suffer a severe blow to their finances if any one of these businesses were to fail due to changes in the competitive environment, shifting demand or simple mismanagement. If a major event were to affect the whole community, the localized investor could be wiped out.
Consider the fate of downtown businesses in a city that has lost its major employer or the communities in eastern Kentucky that have been devastated by flooding and will likely struggle to recover. As for liquidity: investments in local businesses are not easy to sell because they are not traded on a market that matches buyers and sellers practically instantaneously on an ongoing basis A well-diversified stock market portfolio may appear to be more volatile but it is much less vulnerable to being wiped out by a single event and can readily be turned into cash.
This is why the SEC (Securities and Exchange Commission) restricts marketing of illiquid investments to “qualified investors”, meaning those who can easily afford to lose their money.
Localizing Your Investments Narrows Your Opportunities
An investor who focuses only on local investing is missing out on a huge range of investment opportunities that could deliver higher returns. Businesses that are being financed by their local communities are by nature small and tend to represent a much narrower range of economic sectors than the economy as a whole. Smaller businesses cannot easily take advantage of the economies of scale that enable big companies to generate more profit for every dollar invested. Many communities lack the fast-growing industries that can generate higher returns for their shareholders. Investors who localize their portfolios are not just taking on higher risk, they may also reap lower returns on their investments.
Localizing Your Investments Raises New Ethical Issues
No community is an island, to misquote the poet John Donne. Many see local investing as a way to make their communities more resilient and more sustainable but they are forgetting that we are all interconnected and that it does no good for a single community to be able to take care of itself and be more sustainable if the broader society is neither. An exclusive focus on local progress ignores that reality.
Inequality is a major issue in American society today and investors who hoard their capital at home in order to improve their own communities are making it worse. They can advance social and economic progress more by channeling their investments towards marginalized communities that have been deprived of capital and lack the ability to invest locally and sustainably.
Investors who shun shareholdings in “faceless” corporations in order to invest in their neighbors’ businesses are giving up the ability to affect change on a wider scale. It is simply not true that big companies are indifferent to pressure from shareholders and others. In recent years we have seen shareholders force big oil companies to address climate change more forthrightly and there have been many shareholder-driven improvements in corporate transparency and governance. And Disney’s employees forced it to take a stand in support of LGBT rights in Florida.
It is true that a lone individual is rarely able to effect change but collectively activist shareholders can have a major impact. Large public sector pension funds such as CalPRS and non-profits like the Unitarian Universalist Association and the Rockefeller Foundation are constantly pushing the companies they invest in to improve their treatment of the environment, of shareholders and of employees. Many mutual funds that any individual can invest in are doing the same. An investor with a localized portfolio is weakening the ongoing struggle to make shareholder capitalism more sustainable by withdrawing from the fight.
Go Ahead and Invest Locally but Don’t Make it Your Focus
None of this is to say that it is completely wrong to invest locally. There is absolutely a place for local investing. But it should only be part of a sustainable investment portfolio given the potential for higher risk and lower returns and localization’s inadequacy for effecting change in our broader society.
Urban Larson
Principal
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