You invest to build wealth and create financial security, but what if your portfolio could also benefit the greater good?
Well, thanks to socially responsible investing (SRI), it can. Socially responsible investing is an investment strategy based on choosing socially conscious investments, thus doing your part to make the world a better place. And, in a society where social concerns are becoming more important than ever to many people, it should come as no surprise that a growing number of investors are concentrating on SRI.
According to a 2018 survey, 81 percent of investors want to make a positive impact on the environment with their portfolios, and another 80 percent want their investments to create a positive social impact. This increased focus on socially responsible investing led to SRI assets topping $12 trillion in the U.S. in 2018 — a 38-percent jump from just two years ago.
But what, exactly, is socially responsible investing? How do you know which investments qualify as socially responsible? And how do you weigh supporting socially responsible companies against the financial return of your portfolio?
Let’s examine the world of SRI and discover how you can make money and feel good about the broader social impact of your investment choices.
How does socially responsible investing work?
Socially responsible investing is an ethical, values-based investing approach that promotes social and environmental considerations along with potential financial returns.
SRI involves something called negative screening — that’s when you build a portfolio that excludes certain types of companies considered morally or ethically questionable. For example, a socially conscious investor might not invest in companies that produce or invest in alcohol, firearms, gambling, adult entertainment, and/or tobacco. They may also avoid businesses that have a reputation of contributing to climate change or other environmental harm, engage in stem-cell research, or have had accusations of child labor levied against them.
Socially responsible investing is designed to allow your personal values to guide your investment decisions. This doesn’t mean you’re less interested in earning returns; it just means you’re committed to investing in companies that align with your values and beliefs.
And while you might think that SRI investing limits your earnings potential, a 2017 study found that socially responsible investments delivered returns that were comparable to broad market indexes, such as the S&P 500 and the Russell 3000.
Is SRI the same as ESG or impact investing?
No, not exactly.
Socially responsible investing often gets grouped together with ESG (short for environmental, social, and governance) and impact investing under the values-based investing umbrella. In certain circles, SRI is being redefined as “sustainable, responsible and impact investing” but when it comes to building a sustainable portfolio, these strategies aren’t the same.
ESG investing, defined
ESG investing involves picking investments based on environmental, social and corporate governance factors. The Forum for Sustainable and Responsible Investment outlines some guidelines for ESG criteria, but how individual companies adhere to them is totally subjective.
What distinguishes ESG from socially responsible investing is how investments are chosen. ESG investing typically uses a positive screening process, rather than a negative one. So instead of avoiding companies based on ethical grounds, you actively seek companies that fit the socially responsible mold, based on ESG criteria.
Impact investing, defined
ESG investing is similar to impact investing, which also uses positive screening for investment decisions. Where they differ, however, is their underlying goal.
Impact investors worry about the positive environmental, social, and governance effects a company’s products or services have on the world, while ESG investors typically focus on how a company’s operations translate to risk and performance.
The socially responsible investing difference
Socially responsible, ESG, and impact investing are based on the same concepts: Good governance, environmental causes, and positive social outcomes. They also frequently follow political, social, and environmental trends, such as climate change, green energy, and ethical business practices.
The key difference is how these concepts and trends are applied when choosing investments. Socially responsible investing, in its traditional form, is primarily exclusive. ESG and impact investing, on the other hand, are inclusive.
Why socially responsible investing matters
Sure, earning money plays a role in socially responsible investing. But it also has other benefits.
The first is that socially conscious investors may feel better about investing their money in companies that fit their values. SRI is a way to champion the causes you support. For some, getting a financial return on their investments may just be the icing on the cake compared to the emotional return provided by SRI.
Then there’s the bigger picture. When socially responsible investors lean toward companies that act ethically and/or promote sustainability, it sets an example for other corporations. If more people invest with SRI strategies in mind, it could encourage less socially responsible companies to step up their efforts in order to attract more investors. When that happens, the world as a whole could benefit.
Building an SRI-focused portfolio
If you’re ready to do your part through socially responsible investing, consider Self-Directed Trading through Ally Invest. This options allows you to decide what you want to include in your portfolio: individual stocks, ETFs, bonds, mutual funds, index funds — or a little of everything.
Self-directed trading allows you to be fully in control of where and how you invest, which means you can customize an SRI portfolio to highlight the causes or values most important to you.
If you’re taking a self-directed SRI path, follow these steps:
1. Start with your values
Before you pick an investment, decide what matters to you. Are you more focused on the environment and climate change? Are you a social-justice warrior? Or is reining in corporate corruption something you’re passionate about?
Tip: Drilling down which values you want your portfolio to promote can help steer your decision making.
2. Decide how to screen
Whether you use positive or negative screening — or a combination — is up to you. But remember that one approach could leave you with a different pool of companies than the other, so it’s important to understand the difference between screening processes.
Guide yourself in the right direction by referring to your list of values. For example, if your values speak more to avoiding certain types of companies, then a negative screening strategy might work best. On the other hand, if you’re more worried about the results a company produces on an ESG scale, positive screening is probably the way to go.
3. Keep diversification in sight
One great thing about selecting your own investments is that you can pick and choose what to include in your portfolio.
Aside from the numerous publicly traded companies that follow SRI and ESG practices, you can also mitigate risk by investing in funds. ETFs, mutual funds, and index funds can give you exposure to a basket of stocks and bonds that are socially responsible or ESG-focused. While each have their own benefits in terms of active management, tax efficiency, and benchmarks, they’re all generally less risky than investing in individual stocks. Ally Invest offers a set of commission-free ETFs that offer socially responsible options.
Other low-risk options include green bonds or climate bonds, which are used for funding climate change and environmental projects.
As you’re adding responsible investments to your portfolio, remember to keep your overall mix of assets in mind. Investing in an index and ESG fund that include the same companies, for example, could raise your risk profile. It’s important to dig in and do your homework so you don’t end up over-exposed in any one direction.
Start socially responsible investing today
Building wealth and achieving financial security can be accomplished without investing in sketchy business owners like Mr. Burns and wasteful mega corporations like the Springfield Nuclear Power Plant from “The Simpsons.” But instead of just passing out petitions like Lisa Simpson, why not stand up for what you believe in through your investments?
Socially responsible investing is a growing trend that allows you to take action through your investments.
Are you ready to invest in society? The planet?
Be socially responsible by investing in the things you value.