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As climate change becomes a more urgent issue every year, more and more consumers are considering how their purchasing power can influence big corporations to take steps to be more green, whether that’s reducing their carbon footprint or offering transparency into their manufacturing practices.
But if you care about the future of our Earth, the power of your dollar isn’t just limited to buying recycled goods. You can take the same approach when it comes to investing.
Socially responsible investing (SRI) — which also goes by other names like environmental, social and governance (ESG) investing as well as impact investing— is a way to put your hard earned dollars to work that considers both your financial returns and overall impact on the world around you.
In fact, socially responsible investing has piqued the interest of many investors, and the trend continues to grow. At the beginning of 2020, U.S. assets under management that engaged in ESG investment strategies grew to $17.1 trillion, experiencing a 42% growth compared to the beginning of 2018.
Tristan Blaine-Gonzalez, a California-based small business lawyer, is one of the millions of investors who engages in socially responsible investing. He believes that everyone, including businesses, need to work toward maximizing their positive impact.
“As an investor, I want my money to go to companies that believe in these basic values. I also believe that these practices are simply good for business, in the long run,” he says.
Blaine-Gonzalez does his research by looking at companies that focus on green technologies, are working toward being carbon negative or have a certified B-Corps status. Even though he uses Robinhood, investors can go with almost any brokerage to build their own portfolio.
If you’re someone who’s interested in aligning your values with your investments, we’ll go over the basics of socially responsible investing and how you can get started.
What is socially responsible investing?
Socially responsible investing refers to an approach to investing where the investor considers both the value of a company’s broader impact on the world and its potential financial returns.
“[This type of investing category] is a way of investing that incorporates both an investor’s desire to achieve a certain level of financial performance, along with consideration of environmental, social and corporate governance (ESG) factors that may generate a positive societal impact,” says Nicole Middleton Holloway CFP, founder and CEO of Strategy Squad, a wealth management firm.
In other words, these types of investments seek out companies that base their value on alternative energy sources, social justice and environmental sustainability. It also excludes companies (such as tobacco manufacturers) that are known to do harm or aren’t transparent in their business values.
Plus, it also encompasses several more specific approaches within the impact investing sphere. While both ESG and SRI look at a company’s broader impact, there are some distinct differences that affect the types of investments and an investor’s overall portfolio.
SRI investing is not as well defined as ESG investing, says Tara Falcone, CFA, CFP® and founder of fintech company, ReisUP.
ESG investments are measured by and scored on specific environmental, social and governance metrics, whereas socially responsible investing is a bit subjective based on current issues in the political and social spheres, she says. “Many times, SRI investments are assessed through an ESG lens.”
More specifically, ESG investing looks at specific factors such as a company’s best practices when it comes to issues like pollution or child labor, as well as the quality of its leadership. Socially responsible investing, on the other hand, takes these factors into account and also considers the investor’s motives such as their personal values or political beliefs.
Ultimately, many investment portfolios take both elements of ESG and SRI investing into account, which makes it up to the investor to choose how to invest with their dollars.
Benefits of socially responsible investing
One of the main benefits of socially responsible investing is that you can use your money to align with your values, perhaps helping you sleep better at night.
“Investors interested in ESG or SRI investing probably have reckoned with the fact that we do not live in a just, equitable society, and they are looking for solutions to address these disparities,” Holloway says. “ESG investing is powerful because it encourages investors to start engaging with their wealth in a different way, becoming more aware of how they want to use their capital and resources to create a better world, and what they want their legacy to be for future generations.”
Falcone agrees, and adds that it might also make it easier for you to stay invested for the long haul.
“Being confident with your investments gives you an emotional tie to them, which may make it easier stay invested during periods of volatility when you might otherwise be tempted to sell,” she says.
With ESG investing in particular, you could potentially help earn better returns. That’s because these types of investments use traditional financial analysis to weigh potential returns. Not only are you helping to improve a number of social and environmental issues, your portfolio will help you build wealth for years to come.
Drawbacks of socially responsible investing
With any type of investing, there are some potential risks. Sure, you want to make sure your entire portfolio is composed of ESG or SRI investments, but it may come at a cost. Falcone suggests being careful with balancing your values with your financial goals. For instance, it’s easy to hyper focus on a company’s impact but neglect to look at the risk tolerance of an investment.
“If your portfolio is perfectly aligned with your values but doesn’t have the proper allocation or return potential to achieve the goals you’re investing for, then it may not be the best investing strategy for you,” she says.
Another potential downside is that there may be a lack of availability options. If you’re looking specifically for ESG options, you may be limited to what’s offered with your retirement accounts. Holloway also adds that some may have minimum investment requirements, which investors who are starting out may find hard to meet.
With socially responsible investing, you have more flexibility, but you may be mostly on your own when it comes to researching investments that are the right fit. Even if there are ones vetted for you, you may end up paying more fees to do so.
“There’s a lack of universal ESG standards, which makes it more difficult to evaluate investments through this lens and increases the expense ratios portfolio managers charge,” Falcone says. “There also isn’t much long-term performance data on ESG investments, which makes it difficult to confidently project potential future returns.”
Of course, if you’re willing to pay higher expense ratios, that’s fine as long as you’re aware of what you’re getting into.
How you can start building your own investment portfolio
Before you start investing, it’s crucial you define what your reasons are for investing in the first place and what your goals are. Then, look at what resources you have available. Do you have an employer-sponsored plan like a 401(k)? Or do you want to open an IRA or taxable brokerage account?
You’ll also want to consider how much time and effort you want to put into making sure all your investments fall within the realm of ESG or socially responsible investing. If you want to be more hands off, consider investing in socially responsible ETFs, available with a few brokerages like Charles Schwab and Betterment. Seeking out an advisor who specializes in ESG or socially responsible investing is another great option.
For those who are willing to commit more time researching, Holloway suggests looking at a fund’s management team (the more diverse the better), the company’s track record and the goals of the companies within the fund. For example, will you be helping to finance renewable energy sources? Or helping those in marginalized communities?
Don’t forget to look at the fees — see whether you’re willing to pay a higher expense ratio or management fee. If so, you can consider balancing it out with a fund with lower fees to ensure you’re keeping most of your investment dollars.
Whatever avenue you choose, it’s a good idea to start educating yourself on the basics of socially responsible investing, given there are so many ways you can incorporate it into the way you invest. Holloway suggests going to the Forum for Sustainable and Responsible Investment website, since it offers a lot of educational material and a free online course for individual investors.
It is possible to achieve strong financial returns while sticking to your values. It may take some work to build a socially responsible portfolio, but the effort is worth it.
Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.