Socially Responsible Investing: A Beginner’s Guide

Investing is more accessible than ever before. With the advent of beginner-friendly investing and stock trading apps, the power to save and grow your money is in your hands. When it comes to choosing your investments yourself, however, it can still be a bit confusing. On top of trying to determine what investments will grow your savings most, there is so much more to consider – including the social and environmental impacts of the companies you’re investing your hard-earned cash in.

Today, let’s talk about socially responsible investing, including what it means, whether it’s profitable and how it could affect you and the world around us. 

What Is Socially Responsible Investing (SRI)?

Socially responsible investing (SRI) is an investment strategy in which investors put money in companies that not only provide financial returns, but also promote impactful environmental and social change. That means these companies may support causes such as civil rights, anti-war efforts, fighting climate change, etc.

The idea behind SRI is that it empowers the investor to encourage companies to support humanity and the environment’s best interests. If you are a strong believer in clean energy, for example, you might invest in companies that support fighting climate change and promote solar power or electric vehicles. 

Responsible Investing Companies’ Impact On Investments 

So, what exactly is a socially responsible company and how is it impacting your investments? There isn’t really a set-in-stone way to decide if a company is “socially responsible,” but many investors like to use something called an ESG score to evaluate businesses.

ESG stands for environmental, social and corporate governance. An ESG score evaluates how a company performs in terms of their attitudes and policies toward things like pollution, energy efficiency, diversity and the rights and safety of their employees. These scores are calculated by a number of sources, such as Reuters, the Dow Jones Sustainability Index and S&P Global, in order to keep shareholders informed.

According to a 2011 study by Harvard University’s Law School, when companies partake in activities that promote corporate social responsibility or CSR, it creates value for investors, customers and the company by potentially increasing customer loyalty, creating a willingness to pay premium prices and establishing lower reputational risks in times of crisis.

How Socially Responsible Investing Works

If you’re wondering how socially responsible investing works, the short answer is that it works the same as investing in anything else – just with a bit more thought involved. When choosing companies to invest your money in, rather than just choosing based on potential financial returns, you would also take into account whether the company operates in line with your morals and ideals.

For example, if you’re passionate about social justice, you might invest in companies that support people of color, women and other marginalized groups. There are many mutual funds now centered around investing in socially responsible companies, making it a little easier if you’re not sure what individual businesses to support.

It’s important to remember that not all companies are socially responsible – or they may take actions that conflict with your beliefs. For example, if you invest in a company that mistreats its employees or actively contributes to pollution, you may choose to stop investing in their business because of their negative impact.

Types Of Socially Responsible Investments

For those looking to become socially responsible investors, there are a number of ways to do so, including:

• Mutual funds: As we mentioned earlier, there are now plenty of socially responsible mutual funds out there that invest in businesses with positive ESG scores.
• Exchange-traded funds (ETFs): An exchange-traded fund is an investment similar to a mutual fund, except that it can be traded throughout the day at different prices while a mutual fund trade can be executed only once per day. There are a number of socially responsible ETF options as well.
• Alternative investments: You can also invest in hedge funds and property funds that invest based on ESG criteria. Property funds are similar to mutual funds but invest in property rather than companies. Hedge funds are also similar to mutual funds but use riskier tactics to seek returns, such as investing with borrowed money or short selling – so if you go this route, be aware that there is more risk involved.
• Community investments: Community investments are investments that use your money to create opportunities for people and businesses in your local community. For example, you might invest in community development loans that provide financing for resources like housing to disadvantaged groups. Community investments are a great option if you want to see your money at work at the immediate local level.
• Microfinance: Microfinancing is another slightly out-of-the-box option you could pursue at the local level. Rather than investing in corporations, you might invest by offering small loans to local businesses and start-ups that may lack access to traditional financing.

5 Ways To Be A Socially Responsible Investor

Whether you are already aware of ESG scores and are investing your money mindfully or you’re just learning about this investment philosophy, there are plenty of strategies you can adopt to improve your process. Let’s talk about a few ways you can work to become a more socially responsible investor.

Negative Screening

Negative screening is the process of “screening” your investments to assure they are in line with your ethical and moral beliefs. Essentially, this means that if a company is doing something that you believe has a negative impact on the world – such as producing weapons, cigarettes, burning fossil fuels, mistreating employees, etc. – you would choose not to invest in that company.

Positive Investing

Positive investing, on the other hand, means you would seek out companies to invest in that are making a directly positive impact on our world. That might mean the company is producing electric vehicles, working toward increased sustainability, adopting solar energy, investing in resources for underserved and marginalized groups, etc.

Impact Investing

Impact investing is a more extreme version of positive investing. By adopting this strategy, you might start investing only in companies that are actively attempting to solve global issues as one of their main priorities. That might mean they are trying to fight global warming or homelessness, for example.

Community Investing 

Community investing is another way you can start becoming a more socially conscious investor while impacting your own local community directly. As we mentioned earlier, community investing involves putting your money in local investments that serve your immediate neighborhood, such as community development banks and credit unions that may support small businesses and affordable housing.

Shareholder Action

In terms of your existing investments, you can also be a more responsible investor by asserting your rights as a stockholder when necessary. Shareholder action, or shareholder direct action, refers to the act of suing a corporation or its director should the company take actions that directly harm its investors. For example, if a company you invest in makes some extremely rash decisions that drastically harm stock price, you could sue on behalf of its shareholders to recoup the losses you suffered as a result of the company’s actions.

How Profitable Is Socially Responsible Investing?

One key concern of investors is whether investing more mindfully is actually profitable. The point of investing is to put your money in places where you think it will find the greatest returns and involving the ethics of corporations may seem counterintuitive to some. However, socially responsible investments that score well in ESG criteria have proven to be just as profitable as traditional investments – if not more so.

According to data gathered by RBC Capital Markets and shared by the New York Times in August of 2020, 64% of actively managed ESG funds beat their benchmarks compared to 49% of traditional funds in August of 2020. More investors have become interested in corporate responsibility and sustainable investing in recent years, and with the growing interest has come increasing returns.

Pros And Cons Of Social Investing

Like any investment strategy, socially responsible investing has its pros and cons. Let’s talk about some of the benefits and downsides to this method of growing your wealth while also trying to make a positive social impact.

Pros 

• Investors can use their money to align with their values. When you invest in socially responsible companies, you can feel good about where your money is placed knowing that the companies you’ve chosen to invest in share your goals and values and are working towards making the world a better place.
• This encourages investors to decide how they want to use their money and resources. As investing becomes increasingly accessible for all, being a little pickier about where we place our hard-earned cash empowers investors in new ways.
• There may be increased returns. As mentioned above, socially responsible investment portfolios with high ESG scores perform typically just as well as traditional funds, sometimes better. Investing in more sustainable companies may benefit your wallet as well as the world around you.
• It influences companies to engage in socially responsible behaviors. If consumers increasingly invest in companies that are striving to do better for people and the environment, companies may be swayed to engage in more socially conscious behavior in order to keep investors interested.

Cons

• It can cause investors to forget to consider the risk tolerance of an investment. Most investments carry some form of risk – and if you’re investing only based on the sustainability or social consciousness of a corporation, you may run the risk of taking a financial loss that you’re not prepared for.
• There can be a lack of available options. Not every company operates in ways that would earn them a high ESG score. Some of your biggest current investments may not be options going forward if you decide to only put your money toward sustainable and ethically solid companies.
• They may pay more fees. Another downside of investing in ESG portfolios is that there might be more fees involved in exchange for the peace of mind that you’re investing in good and ethical businesses.
• There’s no guarantee. By no guarantee, we mean both that there’s no guarantee socially responsible investments will be profitable, just like with any investment. In addition, there’s no guarantee that the companies you’re investing in are truly socially conscious and making ethical decisions.

What Is The Difference Between ESG And SRI?

ESG investing falls under the umbrella of SRI. Socially responsible investing comes in many forms, and evaluating investments based on their ESG score is a natural extension of this. To recap, ESG stands for environmental, social and governance, and scores how well corporations behave in these three spheres. Investors looking to make more mindful investment choices might consider the ESG scores of companies to better inform their investments going forward.

Why Invest In Socially Responsible Investments?

The point of making more socially responsible investments is to find a way to make solid financial returns while also making the world a better place. Ideally, investors will choose to grow their money with companies that are creating positive change in the world, which creates value across the board for companies, investors and humanity overall.

In terms of making change, especially if you’re passionate about protecting the environment, it can be hard to make a big difference as an individual person. Through socially responsible investing, however, the hope is that your investment along with many others can sway corporations to use their larger platform and resources to make a difference on the people’s behalf.

How To Start Investing Responsibly

Now that you know what SRI is, let’s talk about the actual steps you can take to get started today. 

Step 1: Establish Your Social And Financial Criteria 

Before you can start investing, you will need to think about what causes you’re passionate about. It may help to make a list. Do you want to see more clean energy in the world? Maybe more affordable housing? Would you like to see companies fight for fair and equal treatment of all their workers? These are just a few examples. Pick a few things that are important to you.

If you’re not sure where to start, look at the United Nations’ 17 Sustainable Development Goals (SDGs). These goals include ending poverty, world hunger and other issues that may help give some direction to your investment portfolio’s goals. 

Step 2: Allocate Your Portfolio Appropriately

Once you’ve considered your social and environmental causes, it’s time to allocate your portfolio to reflect what you came up with. That means choosing where and how to invest. If you’d like to consider the individual ESG scores of companies you’re considering investing in, you can find them on sites like Morningstar’s Sustainalytics ESG Risk Rating List.

If you’re investing through a retirement plan like a 401(k) or Roth IRA, be sure to account for risk when choosing your investments. When you’re saving for retirement, it’s important to make sure your money has a good chance of growing significantly over time.

Step 3: Find Funds And Investments

If you’re looking for a socially responsible mutual fund, there are plenty of options available to you. Many sites like Forbes offer lists that showcase the best ESG funds of the month and explanations to why each one made the list.

Be sure to check which companies these investment groups choose to pool their money in. Many invest in Microsoft, Apple, Amazon, etc., and you should assure that you support all the companies on each list. 

Step 4: Contact A Financial Expert

Investing in companies and keeping an eye on their ethics and impact at the same time can be very time consuming. It’s a good idea to contact a financial expert or consult the help of a robo-adviser to keep your investments in check. Many robo-advisers now offer ESG options, including Betterment, Wealthsimple and Schwab. If you invest spare change with an app like Acorns, you can now even choose to put your money in an ESG group portfolio that way, too.

The Bottom Line: Research And Determine The Values You Want To Promote

Socially responsible investing enables investors to earn money and promote the things that are important to them at the same time. It’s a natural evolution of investing and one that puts power back in the investor’s hands. If you’re interested in getting started with more socially responsible investing, remember to do your research, both on the risk of your investments and the companies you choose to invest in.

To learn more about investing in sustainability and social change, check out our guide to impact investing.