Investing is one of the best ways to build wealth over the long term. However, for many people, investing in causes they believe in is just as important as earning a positive return. That leads some investors to put their money where their mouth is and to choose investments based on factors like social responsibility in addition to profitability.
Some experts even believe socially responsible investing (SRI) will outperform investing done without considering social factors. If you’re interested in socially responsible investing, here’s what you should know.
What Is Socially Responsible Investing (SRI)?
Socially responsible investing (SRI) is an investing strategy that has two goals: generating a positive return for the investor and generating positive social change. There are many names for SRI, including ethical investing, sustainable investing, and values-based investing.
For example, many people consider climate change to be one of the biggest threats currently facing humanity. A socially responsible investor might choose to buy shares in companies focusing on renewable energy and to divest themselves of investment in fossil fuels.
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These investors hope that by choosing investments based on more than just traditional investing metrics they can help effect positive change.
What Defines a Socially Responsible Investment
What defines socially responsible investments can vary from person to person based on their personal moral and ethical beliefs. However, there are a few things that hold true across SRI investors.
A popular concept for SRI investors is environmental, social, and governance (ESG) investing. Many investors focusing on SRI look at these three factors when choosing investments.
Environmental factors include sustainability and the impact of a company on the environment. Businesses that focus on green energy or that take efforts to reduce their carbon footprint rank highly here. Environmental-focused investors might avoid high-polluting industries.
Social factors include considerations like diversity within the company, human rights records, customer satisfaction, labor practices, and community outreach. A company that is known for poorly-paid employees that have to work in poor conditions would score poorly here. A diverse business that pays good wages to all employees would rate highly.
Corporate governance factors are details like the diversity of leadership and board members, political and lobbying activity, and the gap between executive and non-executive pay. Businesses with diverse leadership and executive compensation that isn’t miles above the pay for other employees will rank highly.
Although many SRI investors consider ESG factors when making investment decisions, they may go even further. For example, an alcohol company can score highly on ESG factors. However, an SRI investor who wants to support reducing alcohol consumption because of the damage it does to people would avoid investing in businesses that produce or profit from alcohol sales.
Ultimately, what defines a socially responsible investment is that the investor chooses the asset in part because they believe their investment will support positive changes in the world. At a minimum, it means divesting themselves of investments that are social negatives.
Socially Responsible Investment Financial Performance
Although investing based on your beliefs and trying to make the world a better place is great, one of the primary goals of investing is to make money. SRI isn’t worth doing if it doesn’t both generate social impacts and produce a return.
The good news for SRI investors is that, historically, socially responsible investing has produced similar or better returns than investing in most stock indexes.
Between 1990 and 2014, the MSCI KLD 400 Social Index — which invests in businesses based on ESG factors — outperformed the S&P 500, returning 10.14% per year to the S&P’s 9.69%. Compounded over 24 years, that outperformance equals an excess return of more than 100% over the entire period.
Between 2008 and 2018, the MSCI World SRI Net Total Return Index (an SRI-focused fund) and the MSCI World Net Total Return Index (a global, broad-market index fund) both saw almost identical returns.
Assuming historical trends hold true, that means SRI investors either benefit from the consideration of social responsibility or, at minimum, don’t miss out on meaningful returns because of their investing ethics.
There are many reasons SRI investments may match or outperform other investments.
One is that there is a correlation between positive ESG factors in a business and business performance. For example, one could argue that a company that treats its workers well and encourages diversity has an advantage when it comes to retaining employees and getting them to work efficiently.
Another reason is that customers may have a preference for buying products from socially responsible companies. This can be a competitive advantage that translates into increased revenues for socially responsible businesses.
The rising popularity of SRI investing may also lead more investors to want to buy shares in these companies, which drives up their stock price.
Because one of the primary goals of SRI is to effect positive change, investors want to see the impacts their investments have on the world.
ESG investing has continued to grow in recent years. According to Bloomberg, 2021 saw roughly $120 billion invested in ESG and SRI-focused funds. Some argue that this increases access to capital for socially-conscious companies, helping them grow their operations more quickly.
In Europe, the Sustainable Finance Disclosure Regulation has placed rules on companies and how they report their ESG activities. This helps ensure companies that claim to be socially responsible are acting in the ways they say they are.
Many companies, even ones that have traditionally been the opposite of what SRI and ESG investors look for, have made changes to become more socially responsible. For example, carmakers like Ford have increased their focus on electric vehicles, and oil companies like Exxon-Mobile have invested in carbon capture.
SRI investors argue that the pressure they placed on these companies has led them to make environmentally-friendly choices.
Ways to Use SRI Criteria In Your Investing Strategy
If you’re thinking about using SRI in your investing strategy, there are a few ways to do it.
1. Research the ESG Scores of ETFs & Mutual Funds
Investing in exchange-traded funds (ETFs) and mutual funds is a great way to build a diversified portfolio, but limits your ability to choose exactly what to invest in.
Some ETF and fund managers have specific ESG or SRI funds you can use to make sure you’re investing using an SRI strategy. You can also look to third-party ratings to get a sense for whether any fund is investing responsibly or not.
2. Screen Individual Stocks for Social Responsibility
If you prefer to invest in individual stocks, you’ll want to screen companies based on their SRI factors and ESG criteria.
You can do a lot of research yourself by looking into issues like CEO compensation, average wages, whether the company has unions or tries to prevent unionization. But that can be a lot of effort.
Many third parties offer stock screeners that let you look for investment opportunities based on various financial and ESG factors.
For example, you might want to screen for companies based on their employee turnover rates, the ratio of CEO pay to employee compensation, carbon footprint, or other factors.
You can choose the screening filters to use based on your own beliefs and investment goals.
3. Invest in SRI Funds
One of the easiest ways to use an SRI strategy is to buy shares in SRI-themed mutual funds and ETFs. Many fund managers have specialized funds that focus on both positive returns and socially-responsible investments.
Where Can You Make Socially Responsible Investments?
You can make socially-responsible investments almost anywhere.
Like almost all investing, it starts with a brokerage account. You might want to choose a broker based on the broker’s SRI factors too.
Once you’ve opened your account, you can decide whether you want to invest in mutual funds, ETFs, or individual stocks. You can screen funds and stocks based on their SRI or ESG factors and add them to your portfolio.
If socially responsible investing is important to you but you want a hands-off investing experience, you might want to consider a robo-advisor.
Robo-advisors invest for you based on your goals and risk tolerance. With the rise of SRI investing, some robo-advisors have started adding social responsibility as a factor in building your portfolio.
For example, Betterment’s impact portfolio lets you focus your investments on climate and social factors. Wealthfront has a pre-built Environmental, Social and governance portfolio and lets you customize others with ESG investments. Ally Invest also offers a managed portfolio based on socially responsible investing.
You can even apply SRI concepts to other aspects of your life, such as where you have a bank account, what credit cards you use, and where you eat or shop. Voting with your wallet to support companies that are doing the right things is a form of investing too.
SRI Investing FAQs
SRI can get complicated. Here are answers to some of the most common questions about socially responsible investing.
Does Socially Responsible Investing Make a Difference?
It’s hard to know for sure whether socially responsible investing makes a difference. Proponents of SRI argue that it does because it both increases capital availability to SRI-focused businesses and pressures less responsible businesses to change their ways.
Detractors argue that SRI investing doesn’t make a significant difference because many investors still choose to invest without considering SRI.
What’s the Difference Between SRI Investing vs. ESG Investing?
SRI investing and ESG investing are similar in that they both involve investing based on more than just financial return.
The primary difference is that while ESG investing focuses on environmental, social, and governance factors, SRI can have a tighter focus. For example, an SRI investor may choose to avoid any investments involving gambling because they see gambling as socially irresponsible, even if they find a gambling business that follows ESG tenets.
Can I Focus My Impact Investing on Single ESG Issues?
Yes, it’s possible to focus impact investing on single important issues. Some fund managers and robo-advisors offer investments that focus solely on the environment or on social issues. You can also buy individual stocks based on a single issue.
Do SRI Investments Outperform the Market?
Historically, SRI investments have tended to match or outperform market returns. However, keep in mind that past results do not guarantee future ones.
How Do I Maintain Diversification With Socially Responsible Investing?
Diversification is one of the best ways to reduce investment risk. To maintain diversification while using SRI strategies, try to buy shares in multiple companies that align with your beliefs. Investing in businesses in multiple different industries can help shield you from things that impact only one industry.
Socially responsible investing gives you a way to build your savings while effecting positive change. There are many ways to build an SRI portfolio and you can customize your investment strategy based on your investment goals and timeline.
The main drawback is that SRI can take more effort than investing without a focus on responsibility. You may want to enlist the help of a financial advisor or work with a robo-advisor to take some of the load off your shoulders.