Socially responsible investing

Socially responsible investing is more popular than ever. What exactly does it mean and how can you make sure your investments align with your values?

Jennifer Pan

Jennifer Pan

Published February 17, 2020

KEY TAKEAWAYS

  • Socially responsible investing (SRI) is the practice of including or excluding certain companies and industries from your investments based on the impact they have on the world

  • Many people participate in socially responsible investing by owning mutual funds, retirement funds, or other accounts that are specifically created to fit environmental, social, and corporate governance (ESG) criteria

  • Socially responsible investing doesn’t necessarily mean compromising on returns

If you’re new to investing, the process can seem daunting. How do you pick stocks? Should you invest in a mutual fund or ETF? What kind of returns can you expect? And on top of that, how can you make sure you’re not inadvertently investing in companies whose products or business practices go against your own values?

Fortunately, these days it’s easier than ever to put your money to work in a way that aligns with your principles and builds wealth. Socially responsible investing (SRI) — that is, consciously choosing to exclude or include certain companies or industries in your investments based on the impact they have on the world — has grown in popularity over the last several decades. Here’s what you need to know to get started with socially responsible investing.

What is socially responsible investing?

Socially responsible investing (SRI) — also known as ethical investing, sustainable investing, impact investing, or socially conscious investing — is the general term for any type of investment strategy where an investor chooses their holdings based on the social, political, and environmental impact of those companies.

For example, someone who objects to the sale of tobacco or firearms might deliberately steer clear of buying stocks of companies that manufacture those products. Likewise, someone who’s concerned about the environment might avoid investing in the fossil fuel industry and invest instead in renewable energy like solar or wind power.

Socially responsible investing practices aren’t new, of course: Individuals and organizations have always found ways to divest from businesses they disagree with on ethical or moral grounds. In the 19th century, for instance, Quakers refused to support companies involved in the transatlantic slave trade; similarly, in the 1960s, consumers and investors around the world chose not to conduct business with South African companies in order to oppose apartheid.

Thanks to increased public interest in socially responsible investing, there are now a number of options for putting your money to work in a way that aligns with your principles.

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Types of socially responsible investing

It’s easy to avoid buying individual stocks of companies whose products or practices go against your ideals, but what should you do when it comes to accounts like mutual funds or retirement funds, which bundle a variety of holdings?

Socially responsible mutual funds and ETFs

When you invest in a mutual fund or exchange-traded fund (ETF) — which are types of investments that combine different stocks and bonds — you don’t choose which securities are part of that fund.

Fortunately, today there are hundreds of mutual funds and ETFs that are created specifically for socially responsible investing, meaning that the stocks and bonds included in those funds have been pre-selected to meet certain ESG criteria. Most leading brokerage firms have SRI or ESG options, including:

  • Vanguard
  • Parnassus
  • Fidelity
  • BlackRock (iShares)
  • State Street Global Advisors (SSGA)
  • Charles Schwab

If you already have a mutual fund or ETF and aren’t sure whether it’s ESG- or SRI-friendly, you can start by looking at your fund’s prospectus, which is the document that lists all of the fund’s holdings and lays out the overarching investment strategy for your particular account.

You can also talk to a representative at your brokerage firm or to a financial planner to understand what securities make up your fund and what your options are for switching over to ESG investing.

Socially responsible 401(k)s and retirement funds

A 401(k) is an employer-sponsored retirement fund. Though socially responsible 401(k)s are becoming more common, whether you have access to one will depend on your employer and the firm they use to manage employee 401(k)s.

Most people who receive a 401(k) through their employer are enrolled in a target date fund, which is a type of portfolio that’s balanced to maximize growth by a certain date — in this case, the year you’re expected to retire.

Like mutual funds and ETFs, a 401(k) account is made up of a variety of stocks and bonds across different companies and sectors, so you’ll want to consult your 401(k) prospectus to figure out exactly what your holdings are. You can also talk to your benefits manager or HR department to find out whether your company offers any sustainable or socially responsible 401(k) options.

Individual retirement accounts (IRAs) or Roth IRAs, which are retirement accounts that you can open yourself, work much like mutual funds: there are a variety of socially responsible traditional IRA and Roth IRA options available, but you’ll need to do a little research or talk to a financial planner to find the portfolios that best align with your personal values.

How to get started with socially responsible investing

When it comes to SRI, you can, of course purchase individual stocks of companies that align with your values, but investing in a mutual fund or retirement account is a much less risky way of practicing SRI. Here’s how to select a socially responsible fund:

Determine what matters most to you

Maybe you’re vegan and you don’t want to support any companies that sell animal products or use animal testing. Maybe your religious beliefs prohibit alcohol or pork and you want to steer clear of manufacturers of those products. Or maybe you don’t want your money invested in companies that use sweatshop labor or support oppressive governments.

In order to find the investments that best match your values, you can use a resource like the database created by the nonprofit As You Sow, which lists SRI funds by certain criteria, including those that promote gender equality and environmental preservation, and those that avoid tobacco or guns. You can also check Morningstar, an investment research firm that has developed a rubric for rating companies on ESG factors. And most financial sites that track stock quotes will also provide a breakdown of the holdings in a given fund so you can at least see which companies you’re putting your money into.

A financial advisor or a representative at a brokerage firm that offers ESG investments can also help you figure out which funds make the most sense for your concerns.

What kind of returns can you expect?

Most financial advisors agree that practicing SRI these days doesn’t necessarily mean sacrificing returns. A number of popular ESG funds perform as well as the S&P 500 — and, in some cases, even outperform the market — over the long term:

One reason why ESG funds tend to do well over the long term is that companies that adhere to ESG principles are less likely to be involved incidents that might hurt their stock price, like discrimination scandals or environmental disasters.

That said, you should also keep in mind that, like traditional mutual funds and ETFs, almost every socially responsible investment will have an expense ratio (or annual management fee). The exact expense ratio will differ from fund to fund, but in some cases, you may have to accept a higher fee for a fund that meets ESG criteria. For instance, the expense ratio of the ALPS Clean Energy Fund mentioned earlier is 0.65%, whereas the expense ratio of the popular (but far less eco-friendly) Vanguard S&P 500 ETF is 0.03%.

Check with your brokerage firm to understand all the fees and charges that may come with holding an account.

Apps and robo-advisors

There are now dozens of apps and “robo-advisors” designed to help people start investing, and many, such as Betterment and Wealthsimple, offer socially responsible investment options.

Like traditional mutual funds and ETFs, SRI robo-advisors allow you to invest in a diversified portfolio of stocks and bonds pre-selected to fit certain criteria. Many robo-advisors also boast low or no fees.

Read a review of four apps geared toward socially responsible investing.

Is it possible to invest ethically all the time?

While socially responsible investing is more widespread than it once was, it’s still difficult to ensure that 100% of your money is being used for good. Of course, it’s worth doing what you can to match your investments to your values, but there are a few reasons why it can be tricky to account for every cent you invest:

There’s no consensus on what ESG means

Though most major investment brokers offer one or more ESG options, each firm defines ESG differently. So, for example, while one firm’s ESG standards might entail screening out natural gas companies, another’s might not. Likewise, while one firm might prioritize gender equity in their portfolios, another might specialize in renewable energy or companies with good labor practices.

That’s why it’s important to do your research — even when a brokerage says they offer ESG options — and pick the fund that best aligns with your particular values.

Unintended consequences of index funds

Index funds — passively managed investment funds that track a stock index such as the S&P 500 — have become a popular way to invest because they often match (or even outperform) actively managed funds, but charge very low fees.

However, because the securities in traditional index funds by definition span a wide range of companies and industries — including fossil fuels, weapons manufacturers, pharmaceutical companies, and so on — they’re often not the best choice for socially conscious investors.

And while many brokerage firms do offer SRI or ESG index funds that screen out certain companies based on social or environmental criteria, the index fund model itself has recently come under some scrutiny. According to a 2020 Bloomberg Businessweek report, the boom in index funds has inadvertently concentrated disproportionate shareholder power in the hands of a few asset management companies, raising concerns among some antitrust advocates.

Banks may invest in controversial projects

If you’re thinking of investing, you likely already have money in a checking or savings account or use a credit card, and your bank could be funding interests that go against your values.

Though they don’t always make it clear, most major banks invest in a variety of controversial industries and projects. The Dakota Access pipeline — which was backed by Bank of America, Chase, Citibank, Wells Fargo, and other large financial institutions — is one example. On top of that, big banks frequently donate to politicians of all persuasions, meaning that your money might be going toward political causes you disagree with, depending on which bank you use.

To avoid inadvertently supporting companies or politicians you oppose, some advocates encourage moving your money to smaller banks or local credit unions. Read more about ethical banking here.

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About the author

Insurance Expert

Jennifer Pan

Insurance Expert

Jennifer Pan is an insurance editor at Policygenius. She covers life insurance, personal finance, and the economy. She previously worked in marketing and communications in the nonprofit sector and publishing.

Policygenius’ editorial content is not written by an insurance agent. It’s intended for informational purposes and should not be considered legal or financial advice. Consult a professional to learn what financial products are right for you.

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