How would you like to earn a little money while also making the world a better place?
That’s the premise behind socially responsible investing, a relatively new movement that aims to change investing from a purely profit-driven endeavor to one that incorporates your personal values as well.
It’s a cool idea. But does it work?
I talked to a number of financial advisors with a wide range of opinions on this topic to get a better sense of what socially responsible investing is, what the pros and cons are, and how you can get started. Here’s what they said.
One thing is clear: Socially responsible investing means different things to different people. There’s no one clear definition because everyone has a different idea of what it means to be socially responsible.
In general though, it’s a matter of aligning your values with your investments.
“I simply call it values or belief investing,” says Peter Creedon, CFP® of Crystal Brook Advisors. “If you have strong beliefs about religion, climate, war/defense, eating organic, non-GMO, wind, solar, or even support for a country of origin, why not incorporate those beliefs into your investment strategy and portfolio?”
In practice, this typically involves some combination of the following two things:
- Choosing NOT to invest in companies that don’t align with your values. As an example, you could start with the entire U.S. stock market and remove tobacco companies, or those that practice animal testing.
- Choosing TO invest in specific companies that are working to further causes you believe in, like clean energy or income inequality.
And there’s a key difference between this approach and something like charitable giving — because it’s about the investment return you receive, in addition to the cause you’re supporting.
Which means that the goal is really to invest in companies that are both doing good in the world AND are economically viable. When done well, this approach can create even more financial resources that can then be used to do even more good.
Kasey Ring from Upward Personal Finance explains it this way: “Socially responsible investing is about investing in companies who support forward-thinking technologies, environmental or humanitarian issues, and are stewards of a better society.”
First and foremost, it’s simply a good feeling to know that you’re supporting companies you believe in.
“I would rather just invest with those who align with me and leave the end result to come however it may,” explains Ben Martinek of Bona Fide Finance. “Ultimately, getting the largest return in my portfolio is not the most important priority to me. There are some things that money cannot buy.”
But there’s more to it than that. While socially responsible investing is a relatively small movement now, it has the potential to grow. And by being part of the early movement you may make it more likely for positive change to happen.
Marcio Silveira, CFP® of Pavlov Financial Planning explains: “If enough investors have these concerns, they will increase the valuations of securities issued by socially responsible entities, and these higher valuations mean lower cost of capital. The lower cost of capital allow the ‘good guys’ to take on more projects to make the world a better place.”
The returns may be pretty good, too. Multiple advisors I spoke to pointed to a paper from TIAA-CREF showing that socially responsible investors may in fact be able to expect the same returns as other investors.
And Tyler Landes, CFP® of Tandem Financial Guidance believes that it can also lead to improvements in investor behavior, which we know has a significant impact on investment returns.
“Behaviorally speaking, it can help an investor to think proactively and to focus more on what money can enable them to do, rather than on their fear of market performance and having enough.”
Of course, it’s not all rainbows and sunshine. Socially responsible investing is still a new and relatively unproven venture, and there are some big potential downsides to it.
The biggest drawback by far seems to be the cost.
“These funds are typically a lot more costly than a plain vanilla index fund,” says Silveira. “They have to cover the cost of selecting socially responsible companies, the costs of marketing the product, and the profits of the fund manager.”
That’s big because cost is the single best predictor of future investment returns. Higher costs typically lead to lower returns.
Another potential issue is lack of diversification, which is one of the best tools investors have for decreasing their risk. With a smaller number of companies to choose from, it can be harder to spread your investments out over a number of industries and countries.
Some advisors see this improving, but still feel that the smaller opportunity will cause problems going forward.
“Costs and returns should improve but achieving the same return for a given level of risk will most likely never happen,” says Mark Struthers, CFP® of Sona Financial. “Technology and economies of scale will improve the ability of fund managers, but the restrictions will always affect performance.”
Tyler Gray, CFP® of Sage Oak Financial adds: “SRI investors should be keenly aware that sticking to their convictions may cost them something in terms of higher investment expenses, increased risk, and/or lower investment returns.”
Finally, it can simply be complicated to create an investment portfolio that exactly aligns with your values. Daniel Frankel, CFP® of WealthCollab gives this example: “A tobacco company may have a very strong green initiative that is making a big impact. Which is more important, the environmental impact or smoking?”
How to Get Started
The advisors I spoke with recommended doing two things before diving head-first into socially responsible investing:
- Create your overall investment plan. What are you investing for? How much should you be saving? What is your target asset allocation?
- Clearly define what socially responsible means to you. Do you want to avoid certain industries or practices? Do you want to invest in specific initiatives?
Once you’re clear on those two things, you can start to choose specific investments.
Gabe Anderson, CFP® of Crafted Wealth, suggested The Forum for Sustainable and Responsible Investment as a tool for finding mutual funds that fit your values and Motif as a low-cost platform for purchasing those investments. Landes recommended the website Social Funds as another tool for finding socially responsible funds.
Kasey Ring takes a different approach, choosing individual stocks and bonds for her clients. “I encourage this approach since it reduces the fees charged by mutual funds,” she says.
That comes with risks though, too, since most investors don’t have much success trying to pick individual stocks. This is a situation where working with a good financial planner can make a lot of sense.
A few of the financial planners I spoke to emphasized that socially responsible investing isn’t the only way to support your core beliefs, and in some cases may not even be the most effective.
“In my opinion, Socially Responsible Investing is not an efficient way to help the world become a better place,” says Silveira. “Donating to charity can be a lot more effective and has current tax benefits. A great resource to find charities with strong impact is Give Well.”
Or as the immortal Jay-Z once said: “I can’t help the poor if I’m one of them. So I got rich and gave back, to me that’s the win/win.”
Of course, this isn’t an either/or proposition, and as socially responsible investing grows it may be able to make a big impact on the world.
“If words alone are not enough to force advancements in social, environmental, and governance practices, then maybe it can be done through financial means,” says Andrew Novick, CFP® of The Investment Connection. “Put your money where your mouth is!”
Matt Becker is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, The New Family Financial Road Map, guides parents through the all most important financial decisions that come with starting a family.