Socially Responsible Investing – Money Where Your Ethics Are
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I’m a big believer in sustainable and clean energy as one of the best ways to combat climate change. Our home has had solar panels for years. I drove an electric car until its range dropped to a worthless level, and I now drive a hydrogen-powered car.
I’ve also invested in two clean energy ETFs (exchange-traded funds) to add diversification to my investment portfolio and practice socially responsible investing. If I invest in a company, I want to see that it’s working toward sustainability goals, too.
In this article
What is socially responsible investing (SRI)?
Socially responsible investing (SRI) is an investment strategy that aims to make a social impact and provide financial returns. Investment options can include companies that make a sustainable or social impact and exclude those that don’t.
SRI has gone by other names, including impact investing, sustainable investing, community investing, ethical investing, and social investing. The abbreviation SRI also stands for sustainable, responsible, and impact investing.
When researching SRI investment options, more than a company’s or fund’s financial returns and performance are considered. How revenue sources and business practices align with their values are also important and can be measured in social and governance practices and human rights, among other metrics. Each investor may have their preferences.
A portfolio aimed at making a social impact can have investments in green energy, Black-owned or women-run companies, and human rights issues such as paying fair wages. It can also include divesting from a company that doesn’t do these things.
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How to invest in socially responsible investing
This story’s main focus is showing you how to make investment decisions toward SRI (socially responsible investing). But we’ll also review the kinds of financial returns to expect, what metrics to consider, and the costs you may incur. We’ll also explain some common terms associated with SRI.
Non-financial factors to consider
ESG
A term you may hear often around socially responsible investing is ESG, which stands for Environmental, Social, and Governance. Those three factors aren’t commonly part of mandatory financial reporting, though companies are making them more in annual reports or a separate sustainability report.
ESG investing considers how the three factors affect the performance of an investment, with its main objective being financial performance. The goal should be for even responsible investors to profit from such companies.
SRI goes a step further than ESG criteria by eliminating investments according to ethical guidelines such as religion, personal values, or political beliefs. For example, you may not buy ETFs that invest in companies that make firearms, gambling products, alcohol, have human rights violations, or have damaged the environment.
Here are some ESG issues that may be part of those three main ESG factors, according to the CFA Institute, a non-profit organization that provides investment professionals with finance education:
Environmental
- Climate change and carbon emissions
- Air and water pollution
- Biodiversity
- Deforestation
- Energy efficiency
- Waste management
- Water scarcity
Social
- Customer satisfaction
- Data protection and privacy
- Gender and diversity
- Employee engagement
- Community relations
- Human rights
- Labor standards
Governance
- Board composition
- Audit committee structure
- Bribery and corruption
- Executive compensation
- Lobbying
- Political contributions
- Whistleblower schemes
Examples of best ESG companies
One way to find ESG companies is to research ESG ratings to see if a company meets high standards for corporate behavior. One popular rating system is the MSCI EST Rating. Its ratings range from leader (AAA, AA) average (A, BBB, BB) to laggard (B, CCC). It also rates equity and fixed-income securities, loans, mutual funds, EFTs, and countries.
Here are the top four ESG stocks given the top rating of AAA, along with a few highlights of why they scored so well, according to a November 8, 2023, review by The Motley Fool:
Nvidia
Nvidia is the major graphics process unit supplier in the gaming industry, and it provides artificial intelligence. It has a market cap of $391.6 billion, an IBD composite rating of 60, and an IBD relative strength rating of 20.
Microsoft
Microsoft is the world’s largest software company. It has positively impacted energy efficiency and is working toward 100% renewable energy by 2025. By 2050, it plans to offset all its carbon emissions since 1975. It has a market cap of $1,708 billion, an IBD composite rating of 74, and an IBD relative strength rating of 58.
Best Buy
Best Buy is a leading retailer of consumer electronics in North America. Its facility in Chino, California, achieved 100% waste diversion in 2020, a goal the company has for all of its facilities. It has a market cap of $18.3 billion, an IBD composite rating of 34, and an IBD relative strength rating of 22.
Adobe
Adobe is a software and infrastructure company that has achieved global gender pay parity. It has invested almost $87 million in communities to benefit 1.6 million underrepresented minorities. Half of Adobe’s energy comes from renewable sources, with a goal of having 100% renewable sources by 2035. It has a market cap of $160.9 billion, an IBD composite rating of 49, and an IBD relative strength rating of 89.
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SRI financial returns
Feeling good about investment because it’s socially conscious by practicing sustainability, good corporate governance, and respecting human rights doesn’t necessarily mean it’s profitable with great financial returns.
But overall, it should perform as well as any other investment. According to a 2023 analysis by Morgan Stanley, sustainable funds outperformed traditional funds by 3.1% in the first half of the year.
It also found that stocks of companies with superior environmental practices are less volatile than the broad market. Companies deemed more socially responsible have been found to exhibit lower risk, while less socially aware companies appear to be more likely to experience financial distress.
But what does this mean for your investment portfolio? The average stock market return is about 10% annually. By mid-2023, the S&P 500 returned 21% within 12 months, while S&P 500 ESG Index posted returns of 22.5%. While that number seems slight, the same report found ESG performance outperformed traditional stocks at 49% and 73.2% for three and five years versus 43.3% and 61.1%.
A 2021 study by the Morgan Stanley Institute for Sustainable Investing found that stocks, bonds, and mutual funds focused on ESG factors performed better during the 2020 coronavirus pandemic by a median total return of 4.3% better than non-ESG portfolios.
ESG investing also receives higher rankings from services such as Morningstar. A 2021 Morningstar report on sustainable funds found that they outperformed their peers in 2020, with 69% of sustainable funds ranked in the top half of their Morningstar category.
How to start SRI investing
You can start creating an ethical portfolio like any other investment portfolio. You’ll need a brokerage account to start trading, either by buying specific investments, such as certain companies you’ve found to have business practices for ethical investing, or using robo-advisors that use algorithms to recommend companies.
Robo-advisors, however, may not allow you to add specific investments but will instead offer portfolios aimed at social impact.
With an investment account through a brokerage such as Fidelity, you can search for socially responsible mutual funds, ETFs, and even specific stocks as investment options.
Before making any investment decisions, you may want to decide which criteria are important. Do you want to invest in a company that still uses fossil fuels? Do you want women to hold the majority of seats on a board of directors? How fast do you expect it to make climate change decisions?
Whatever criteria you choose, not every company may meet all of them. A business may be working on lowering emissions, but it may take another decade to reach zero emissions. Others may get there sooner or not at all.
Review ratings from research firms such as Morningstaror seek investment advice from Morgan Stanley or another brokerage firm. Investment management, such as asset managers of mutual funds, can set the criteria for a fund, and a brokerage screening tool can lead you to their focus areas.
Somewhere in its prospectus, a fund should have a list of holdings, which is every company the fund is invested in. Research those companies to see if they meet your sustainability criteria, such as clean energy, and check if they meet the benchmark for their industry.
Related: Best Robo Advisors
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Pros and cons
Pros
- Socially responsible investing is a way to invest in companies that meet or exceed your personal expectations for being an ethical company that has a positive social impact, such as through environmental, social, and governance business practices.
- Ethical investing returns often meet an industry benchmark or exceed it.
- Mutual funds are becoming a common way to get into impact investing, and can still allow strong diversification in an investment portfolio.
Cons
- Some companies may just use sustainability only as a label and do what’s called greenwashing and exaggerated claims.
- Not every mutual fund or stock in socially responsible investing may be following all of the criteria you’re seeking from your investments.
- You may be leaving some great investments on the table by only investing in companies that say they’re socially responsible.
The bottom line
If you recycle, drive an electric car, shop at stores owned by minorities, or do anything that’s ethically important to you. You may want to only invest in companies with the same ethics as you do.
Socially responsible investing, which goes by other names such as impact investing and social investing, can be one way to make such investment decisions. Do your research, as you would with any investment, to see if a company’s ethical claims are legitimate and to see if it’s still a strong investment that you’d make anyway. If so, you may have found an investment that will ease your conscience and add some heft to your bank account.
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Writer
Aaron Crowe is a freelance journalist who specializes in personal finance writing and editing. He has worked at newspapers, where he won a Pulitzer Prize, and has written for numerous online publications. These include AOL, US News & World Report, WiseBread, Bankrate, AARP, and many websites focusing on housing, credit and insurance. He lives in California with his wife and daughter.
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