Comparing Costs of Green Stocks vs. Costs of Green Funds

Mar. 5.09 | About: iShares S&P (ICLN)

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The intense and growing investor interest in Clean Energy Investing can be seen in the recent growth of new clean energy mutual fund and Exchange traded fund issues. Although competition for investors' money is heating up, and I've noticed a slow decline in fund fees, those fees are still quite high, with expense ratios ranging from 1% to 2.75% for Clean Energy mutual funds and 0.5% to 0.85% for Clean Energy ETFs.

For many investors, that leaves a lot of room for cost savings by investing in individual stocks. Nearly all the benefits of diversification can be achieved with a 20-50 stock portfolio, if those stocks are chosen to minimize internal correlations. An investor who decides to place 20% of his portfolio in Clean Energy should only need 4-10 stocks in the sector to achieve most of the benefits of diversification.

For example, an investor with $20,000 in a diversified IRA might decide that this year's $5000 contribution should go into Clean Energy. He could buy $1000 worth of five Clean Energy stocks to achieve a 20% allocation to clean energy without significantly reducing his overall diversification, and resolve to purchase another $1000 worth of a single clean energy stock each subsequent year, to maintain that approximate diversification.

The table and graph below show how his costs would compare to investing the same amount in sector mutual funds or ETFs, assuming a moderate $13 brokerage commission. These calculations assume no price appreciation. If price appreciation were included, ETF and mutual fund costs would be higher than those given, because these costs are based on a percentage of assets under management.

Cumulative commissions & expenses

Year Total invested Stocks lowest cost ETF lowest cost mutual fund
1 $5,000 $ 65 $ 37 $ 65.50
2 $6,000 $ 78 $ 79 $ 144.10
5 $9,000 $ 117 $ 233 $ 458.50
10 $14,000 $ 182 $ 586 $ 1,244.50
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The stock investor following this strategy will save money in the first year compared to even the least expensive mutual fund available (the Winslow Green Growth Fund), and by the second year compared to the least expensive clean energy ETF (the iShares S&P Global Clean Energy Index.)

A Quick Way to Choose Clean Energy Stocks

All this assumes the investor has the time to spend to pick appropriate stocks. For a small investor like the one in the example, the time required will need to be minimal. With literally hundreds of clean energy stocks to choose from, the task seems monumental. It doesn't have to be.

One simple way is to look at the top holdings of a few clean energy mutual funds, and pick your stocks from among those. By making sure to spread your holdings over different alternative energy sectors (Wind, Solar, Efficiency, etc.), you'll be able to maximize your diversification. Our CleanTech Stocks page shows stock categories in the right-hand column.

The goal of this strategy would be to approximately replicate the performance of the funds, but to do so at much lower cost. If this were done outside of a tax advantaged account such as an IRA, after-tax performance could be enhanced further by selling losing stocks in order to shield capital gains or even a little ordinary income from taxation, and replacing them with similar companies.