Dec 19, 2022
What is Socially Responsible Investing (SRI)?
Socially responsible investing (SRI) is the ethics-focused practice of investing in companies or funds geared toward positive environmental or social impact. Also known as sustainable investing, ethical investing, and impact investing, SRI strategy is designed to generate both returns for investors and change in society. People may invest in an SRI-focused exchange-traded fund (ETF) or mutual fund, the stocks of individual companies they want to support, or a combo of both.
Responsible investment is a growing trend in the United States, especially among Millennial and women investors. According to a 2020 report from the Forum for Sustainable and Responsible investing, one out of every three dollars under professional management was dedicated to sustainable investing strategies by the end of 2019. That comes out to $17.1 trillion in investments, a 42% increase over the prior two years.
In this article, we’ll cover:
- Why investors choose SRI investing
- ESG factors
- Pros and cons of SRI investing
- Adding socially responsible investments to your portfolio
Why investors choose SRI investing
Everyone weighs different factors based on their personal circumstances when making investment decisions, and for many people, one consideration is being socially responsible. Investing, after all, affects more than an individual’s bottom line; when you put your money into certain companies or sectors, you’re financially supporting their success.
Motivations for choosing an SRI strategy vary widely based on a person’s values, such as religious beliefs, cultural ideals, and personal convictions. For example, an investor who’s committed to fighting climate change may avoid investing in the oil and gas industry in favor of investing in ETFs or stocks that support green energy. An animal-loving investor may put their money into the stocks of consumer goods companies that support cruelty-free products and avoid those that test products on animals.
The personal values that guide socially responsible investing decisions are as varied as people themselves, which often leads to different interpretations of the definition of sustainable investing. For that reason, investment professionals tend to consider SRI strategy based on Environmental, Social, and Governance (ESG) criteria.
ESG criteria: what qualifies as a socially responsible investment?
Environmental, Social, and Governance (ESG) investing uses specific, measurable criteria to identify a socially responsible or sustainable investment. It’s closely related to SRI, and the two approaches often complement each other. The main difference is that SRI strategy is focused on excluding certain kinds of investments from your portfolio, while ESG investing is about including investments that meet the three categories of ESG criteria.
Environmental investing focuses on the conservation of the natural world. Companies that have a negative impact on the environment due to an outsized carbon footprint or a reputation for careless handling of toxic chemicals are unlikely to qualify for this category. Companies that are directly working for environmental improvement in the following areas are generally categorized as ESG investments:
- Climate change
- Water pollution
- Air pollution
- Greenhouse gas emissions
A company’s social impact takes into consideration how its practices affect both individuals, including employees, and the wider community. For example, if an organization is dedicated to improving labor practices nationwide but fails to provide suitable working conditions for its own employees, it’s unlikely to qualify as an ESG investment. The criteria on which a company’s social impact is measured include:
- Gender and racial inclusion
- Human rights
- Labor practices
- Customer responsibility
- Community impact
Governance in ESG investing takes into account the standards for running an ethical company. Organizations that operate with transparency, integrity, and accountability while focusing on diversity in leadership are likely to qualify in this category. Factors to consider include:
- Shareholder rights
- Political contributions
- Hiring practices
- Tax transparency
How do SRI portfolios perform?
Trends show that returns from sustainable investing are growing year over year. A study from the Morgan Stanley Institute for Sustainable Investing found that there is “no financial trade-off in the returns of sustainable funds compared to traditional funds, and they demonstrate lower downside risk.”
Portfolios that rely on an SRI strategy may perform well, especially over the long term, as companies with strong ESG profiles produce more effective and profitable solutions to social problems like climate change and human rights. It’s possible to maintain a diversified and socially responsible portfolio as a growing range of companies and market sectors are focusing on the factors that drive SRI and ESG investing. Many brokerages offer SRI and ESG funds to choose from.
Pros and cons of socially responsible investing
As with every investment strategy, there are pros and cons to socially responsible investing. An SRI strategy can be a practical way to take a stand for your values, and knowing whether a company maintains ethical practices can alert you to potential risks about the organization’s long-term performance. Research has shown that investing in SRI funds can produce returns comparable to traditional funds, potentially with lower market risk.
On the other hand, you may also be missing out on some potentially lucrative conventional investment opportunities if you focus solely on an SRI strategy. The definition of sustainable investing is also subjective; just because an ETF or mutual fund is positioned as ethical doesn’t mean every security it holds aligns with your values, and some companies may attempt to greenwash their practices.
|Pros of SRI investing||Cons of SRI investing|
|Your investments support companies whose practices reflect your values||SRI is subjective, and not all companies in a fund may align with your values|
|Investigating a company for ethical practices may lower your investment risk||Companies may attempt to greenwash their image|
|Your long-term returns may be just as strong as traditional investing, potentially with lower risk||You may be disregarding other potentially valuable investment opportunities|
Building a socially responsible portfolio
Socially responsible investing can be a path to pursuing your goals for the future, both your own financial aims and the change you want to see in the world, so be sure to consider the factors important for both. When you’re putting together your SRI strategy, take into account your risk tolerance and time horizon, just like you would when building any kind of investment portfolio. You’ll also want to research companies and funds based on the ESG categories that matter to you. Do your homework, open an investment account, and investigate the options for putting your money to work for your values.
1. Choose the ESG categories that matter to you
ESG investing is personal, so look at the categories that line up with the issues that you care about. From battling pollution to protecting workers’ rights to ensuring fair hiring practices, your ethics and priorities can lead you in looking for the companies and funds that reflect a responsible investment in your eyes.
2. Open an investing account
If this is your first foray into the world of investing, you’ll need to open an investment account with a brokerage firm. Do some research to find a brokerage that offers investment options that fit your needs. You can invest in the stock of individual companies or funds geared toward socially responsible investing; each brokerage will have different offerings. You may also want to consider factors that affect your needs as an investor, like lower fees, mobile app access, and investor support.
3. Research stocks and funds thoroughly
Once again, do your research. Explore ETFs and stocks that might align with your responsible investment priorities. Thoroughly investigate any companies you’re considering to ensure they truly walk the walk of the values they espouse. Tools like the S&P Global’s ESG Evaluation can help you find out if a security aligns with your SRI strategy.
Sustainable and responsible for the long term
Socially responsible investing and ESG investing offer the opportunity to champion the causes that matter to you while supporting your long-term financial goals. For many people, that’s a win-win: investing in a brighter future for oneself and the wider world at the same time.
Stash can help you build a diversified, sustainable portfolio with ETFs focused on environmentally and socially responsible missions and causes. With any dollar amount, you can start investing today, the socially responsible way.
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