The Pros and Cons of Socially Responsible Investing

Socially responsible investing is an investment strategy that has been gaining traction in recent years. With news of shady and illegal investment deals becoming common, many active investors have begun to insist that the companies they invest in make socially responsible choices. In addition to being good stewards of the environment, these “socially responsible” businesses are expected to treat their employees well, create healthy products and services, and steer clear of unethical or predatory business practices.

In this type of business and the individuals who have a stake in them, investing is not just about turning a profit and growing one’s nest egg. It’s about building and thriving responsibly and sustainably.

While all of this sounds warm and fuzzy, many people wonder if socially responsible investing is a winning investment strategy. Unfortunately, there is no perfect answer to that question. Though it is entirely possible that investments in socially responsible companies will provide investment returns comparable to the general market, these businesses experience the same ups and downs as anyone else.

In this article, I’ll describe what exactly socially responsible investing is, who it might be for, and the different flavors of SRI you may experience. I’ll then play devil’s advocate and discuss some of the pros and cons of this ethical investing strategy, rounding it out with five funds you can look into now if you want to deploy this strategy. Let’s get started by looking at what SRI means.

Best Robo-advisors For Socially Responsible Investing:

What is Socially Responsible Investing (SRI)?

Socially responsible investing, or SRI, is when you strategically invest in companies that have ethical practices. The definition is a broad one, as “ethical practices” vary widely based on who is evaluating them. An example of an ethical practice might be the use of green technology, such as solar panels, for power in the factories where a company manufactures their product. A socially responsible fund, for instance, may avoid investing in specific areas, such as tobacco or firearms.

Who Would Be Most Interested in this Strategy?

Socially responsible investing is for those who have a personal connection to their investments, and want to invest their money in noble causes. There are two sides to SRI–investing in companies that you feel have ethical business operations and probably more so, avoiding companies that you think don’t have ethical business practices, products, or services.

So for example, if you think tobacco is bad for the world, you may avoid investing in companies that produce tobacco products. You may instead invest in companies that focus on delivering local, organic produce at an affordable price. Many people who are against war avoid investing in companies that produce tanks and missiles. A socially responsible investor might want to put their money in a company that has adopted a way to bring clean water to third-world countries.

You get the idea.

What are the Different Types of SRI Funds?

Socially Responsible Investing Funds

There are several “classes” of socially responsible investing funds. The first, and most traditional funds are known merely as socially responsible investing funds, and they avoid companies that play in significant areas of controversy such as gambling, firearms, tobacco, alcohol, and even oil.

Environment, Social, and Governance Funds

The next class is Environment, Social, and Governance funds (or ERG funds for short). Where socially responsible investing funds tend to focus on excluding industries that don’t use ethical practices or products, ERG funds concentrate on including ones that do. There’s a big difference here. Because a fund excludes a company that produces a product like tobacco, it doesn’t mean there aren’t some unethical practices in the companies that are included in the fund–it tows the line in some cases. So ERG funds focus on companies that do function in entirely ethical ways.

Impact Funds

Building off of ERG funds are impact funds. These funds are all ERG funds, but place an equal focus on fund performance, whereas an ERG fund may not. This might mean the company is more aggressive in creating ethical changes with the products and services. An impact fund is an excellent option if you want to be socially responsible, but still, need a stock that performs well. Keep in mind, the more “niche” you get, the fewer the options you have.

Faith-based Funds

Finally, there are faith-based funds, which only invest in stocks that follow Christian, Catholic, or Islamic values. Any company that doesn’t fit this category will be excluded from the fund–and it’s pretty strict.

The Pros of Socially Responsible Investing

When you see someone taking the SRI strategy, it tends to be all-or-nothing. What I mean is, you either fill your portfolio entirely with “socially responsible” stocks and funds, or you don’t put a targeted focus on them at all. Here are some of the benefits of employing a socially responsible investment strategy:

1. You’re talking the talk and walking the walk.

In his book, The Integrity Dividend, Tony Simons talks about how people try to be about too many things at once, and it confuses their brand. He recommends picking a few core values and sticking to them, then living them out in everything you do.

How does this apply to SRI?

If your values are important to you, then socially responsible investing allows you to put your money where your mouth is, so to say. It’s hard to insist you’re a committed environmentalist if part of your portfolio is invested in companies or industries that are destroying the environment. By investing in socially responsible businesses you’re doing more than talking the talk, you’re walking the walk–with your money.

Having this kind of approach, and sticking to your core values, will allow you to focus on other aspects of your financial life, such as automatic payroll savings, college savings, and purchasing a home. The limitations of ethical investing provide you with some assurance that you don’t have to check in on your investments continually. Just pick a few socially responsible funds and go with it.

2. You’re taking a stand.

It’s easy to complain about awkward situations, but infinitely harder to do anything about it. When you commit to socially responsible investing, it’s an opportunity to withhold your investment dollars from businesses that are not behaving. If more people invested only in companies that acted responsibly, the bad apples would be forced to shape up and make better choices.

Now, this is strictly a theory, but if you’re standing for a cause, it might motivate you. It’s the same reason people protest and stand up for purposes that may face insurmountable odds. But if nobody took a stand, no changes would ever happen.

Like all causes, it takes a snowball effect of people getting on board to make a change. Just last year, James Kynge of Financial Times said that “although ESG is still evolving as a concept, the pull it exerts over investors appears to be reaching critical mass.” Ethical investing is growing in popularity, which means more and more people are focused on investing in companies that are doing the right thing. I can’t say for sure what will happen, but I can’t help but think this is a good sign for big companies beginning to shift their practices to be more socially responsible.

3. You’re rewarding ethical companies.

It may seem like it’s being done on a small scale, but socially responsible investing punishes companies that act unethically, and it also rewards companies that are doing the right thing. If you want companies to make more responsible choices, you have to support them in the most tangible way possible, which is through investment capital.

To build off of the point above, the more people that begin to invest in socially responsible companies, the more rewards those companies will see. Long-term, this could be a catalyst for significant social change. A perfect example of this is Lego, who ended their partnership with Shell Oil a few years ago and is now partnering with companies like the World Wildlife Foundation on social initiatives. They’re also working toward having 100% renewable energy capacity by the year 2030 while committing to reduce their overall carbon footprint. Those are causes that couldn’t be funded unless individuals like you were investing in them.

4. You’ll sleep better at night.

If you haven’t picked up on this theme by now, I’ll say it for you. By investing in a socially responsible way, and assuming that it aligns with your values and you’re completely committed, you’ll sleep better at night knowing that you’re trying to do good in the world. Although none of us are perfect, most people genuinely want to do some good in the world. If you can invest your money in socially responsible companies, and make a profit doing so, you’ll have two things to feel good about–making money and using your money to improve the human condition.

The most rewarding feeling when you take an SRI strategy is when the companies you invest in begin to make a profit and reward you financially. Not only does it show that you’re aligned with the values of the companies you’ve invested in, but it also shows they’re profitably doing good. It’s a win-win, and quite rewarding.

You also don’t have to feel wrong about paying a little more for these investments (management fees, etc.) as one study shows that 66% of people around the globe are willing to pay more for sustainable goods. That number jumps to 73% with millennials. It’s always smart to focus on performance, but if you’re doing your research appropriately, you should rest easy knowing that you’re investing in a higher cause.

The Cons of Socially Responsible Investing

SRI isn’t all sunshine, rainbows, and solar panels. While socially responsible investing offers plenty of benefits, there are drawbacks as well. Here are a few cons:

1. Ethics might become more important than performance.

You’ve probably considered this point by now. When you limit your investment options and potentially pay more to invest in companies that practice social and ethical responsibility, you may give up on your return on investment. Let’s not forget the reason we’re investing in the first place–obtaining the highest return on investment possible. When socially responsible investing becomes the primary objective, the financial side of the equation will likely suffer–at least part of the time.

For example, one financial advisor writing for Seeking Alpha pulled some data and showed that on a 3, 5, and 10-year comparison basis, funds that were considered socially responsible underperformed standard indices. Marketwatch columnist Vitaly Katsenelson also wrote an in-depth opinion piece on why socially responsible investing can be a money pit.

Now, there is some data to validate this claim, but some of it is opinion. My advice is to do your research and find stocks that align with your values, but also don’t go outside of your guidelines for picking any other stock. For example, if you take a value investing approach and only want stocks that pay a dividend and don’t carry debt, don’t break that rule just because a company considers itself to operate ethically.

2. You may be leaving a lot of great investments on the table.

Building off of the point above, if you focus solely on socially responsible stocks and funds, you could be leaving strong investments on the table. Let’s say you find a new company with below average performance regarding social responsibility, but a history of creating innovative products and services that improve lives and generate jobs. If you pass on this attractive investment opportunity because of the social responsibility factor, you may lose out.

The converse of this is true as well. If you choose not to invest in a company because you don’t consider them ethically responsible, you might be missing out on a perfect investment. An excellent example of this is Microsoft, which isn’t included in one of the largest and most successful socially responsible funds–the Parnassus Core Equity Fund. Todd Ahlsten, one of (the two) managers of the fund, said in an interview that they don’t invest in Microsoft because of its “competitive dynamics.”

3. Many companies claim to be socially responsible, but they aren’t.

Putting a marketing spin on anything for sale is part of a modern business culture. In many cases, it’s more important to craft the image of being socially responsible than to actually be socially responsible. As the saying goes, it’s not the truth, but what the people believe that counts. With the right marketing campaign, people will believe nearly anything.

Volkswagen is an excellent example of this. Their commercials and general image portray social responsibility. For a long time, they put a hefty amount of marketing into their “clean diesel” cars–marketing them as safer for the environment. This lead to a scandal, which later began to unravel Volkswagen’s image of being an ethical company. Even recently, Audi (owned by Volkswagen) CEO Rupert Stadler resigned amid criminal investigations related to the scandal.

The lesson here is that just because a company says its socially or ethically responsible, doesn’t mean it is. This can be blatant or, as I’ll discuss below, much more subjective.

4. The definition of socially responsible investing is highly subjective.

What constitutes socially responsible investing is not always universal. Perhaps the best example is nuclear energy. If viewed from a perspective of damage from nuclear accidents, it might be seen as one of the worst investments possible. But if it is considered to be a substitute for fossil fuels, it could constitute a socially responsible industry. You can see how this can cause both outward and inner-controversy when selecting a fund or individual stock.

As I stated above, Microsoft was excluded from one of the most significant SRI funds because of the way it operates its business–not because they’re dumping toxic chemicals into the water. On the flipside, the iShares MSCI KLD 400 Social ETF has companies like ConocoPhillips, Occidental Petroleum, McDonald’s (which has been accused of unfair labor practices), and Aramark (same thing) listed in their holdings. Those stocks, it can be argued, go against traditional SRI guidelines.

So as you can see, what is considered “socially responsible” is getting murkier as these types of funds grow in popularity.

How to Become a Socially Responsible Investor

If you’re trying to be a socially responsible investor, you should be going out of your way to buy funds that meet that criteria.

The simplest way of doing that is with a robo advisor, which will manage and invest your money for you based upon your own individual risk tolerance. Some of my favorite robo advisors have socially responsible investing tracks, including Personal Capital, which focuses on ESG (Environmental, Social and Governance) metrics, and Betterment, which also offers SRI alternatives for large cap U.S. stocks and emerging market stocks.

Ally Invest now has what they call Managed Portfolios–which is their version of a robo-advisor. They now feature a socially responsible portfolio option that, according to Ally Invest, is “shaped by companies with ethical track records,” and “you’ll only invest in businesses that actively practice sustainability, energy efficiency or other environmentally-friendly initiatives.”

Ally Invest has NO advisory fee, either, which makes it a huge bargain. You can open an account with as little as $100 and you’ll also get call, chat, or email support at no additional cost. Make sure you read our complete review on Ally Invest for more details on their Managed Portfolios.

If you’re more the DIY type, below are five fund options that fit the SRI bill. Usually, they measure their performance against a socially responsible investment index, such as the MSCI KLD 400 Social Index. However, since the S&P 500 Index is the most common benchmark used to measure an investment’s performance, I decided to show their recent five-year annualized performances against it instead.

Parnassus Endeavor Investor (PARWX)

This fund aims to invest at least 80% of its capital in companies that the fund managers believe provide good workplaces for their employees.

• Top 5 holdings: Qualcomm, Gilead Sciences, Mattel, Micron Technology, Allergan PLC
• Expense ratio: 0.92%
• Minimum investment: $2,000
• 5-year annualized return (through 6/22/18): +16.49%
• Versus the S&P 500 during that same period: +2.56%

Vanguard FTSE Social Index (VFTSX)

This fund tracks a benchmark of large and mid-capitalization stocks that have been screened for certain social, human rights, and environmental criteria.

• Top 5 holdings: Apple, Microsoft, Facebook, JPMorgan Chase, Alphabet Inc (Google)
• Expense ratio: 0.20%
• Minimum investment: $3,000
• 5-year annualized return (through 6/22/18): +14.75%
• Versus the S&P 500 during that same period: +0.83%

Calvert Equity Fund (CSIEX)

This fund invests in companies that demonstrate a history of positive environmental, social, and sustainability practices.

• Top 5 holdings: Danaher Corp, Visa, Thermo Fisher, Alphabet Inc (Google), Microsoft
• Expense ratio: 1.08%
• Minimum investment: $1,000
• 5-year annualized return (through 6/22/18): +13.69%
• Versus the S&P 500 during that same period: -0.24%

Walden Equity (WSEFX)

This fund invests in socially responsible companies for long-term growth. While screening for companies that have positive records on community investment, the environment, human rights, and employment practices, they avoid companies engaged in the production and sale of weapons, animal testing, nuclear power, alcohol, tobacco, and gambling.

• Top 5 holdings: Apple, Microsoft, Alphabet, Visa, JPMorgan Chase
• Expense ratio: 1.00%
• Minimum investment: $100,000
• 5-year annualized return (through 6/22/18): +12.00%
• Versus the S&P 500 during that same period: -1.93%

Domini Social Equity (DSEFX)

This fund conducts in-depth social and environmental research on each of their holdings. Meanwhile, they also look for companies that respect their communities, protect the environment, produce safe and useful products, and treat workers, investors, and suppliers fairly.

• Top 5 holdings: Alphabet, Mastercard, Intel, IBM, Prudential Financial
• Expense ratio: 1.09%
• Minimum investment: $2,500
• 5-year annualized return (through 6/22/18): +10.35%
• Versus the S&P 500 during that same period: -3.58%

Bottom Line

Based on the performance of the funds listed above, socially responsible investing seems like a reasonable proposition. In the end, it may come down to a matter of conscience. If you value socially responsible investing more than the prospect of making money at any price, you might be willing to sacrifice some returns to invest your money in companies that you believe in.

Read More: Best Robo Advisors – Find out which one matches your investment needs.

Is corporate social responsibility important to you? What constitutes a socially responsible investment in your eyes?