What Does Socially Responsible Investing Look Like?

Last time, we looked at the motivations for using socially responsible investing. But that’s just the start. Today, we’re going to look at how to actually start putting a socially responsible portfolio together. There are two big things you need to be thinking about:

  • What criteria do you care about?
  • What approach to socially responsible investing will you use?

Your Criteria

Everyone’s definition of “socially responsible investing” is different. Your reasons for calling a company good could be the same reasons someone else considers it bad. It all depends on which screen you’re using—environmental, religious, social justice, and many, many more. Even within each individual screen, there are serious gradations.

For instance, let’s say you want to avoid investing in the adult entertainment business. That might seem simple enough, just don’t invest in the companies that produce or host that content, right? But what about hotels? They make a good amount of money off pay-per-view adult movies (although the internet has seriously  diminished that revenue stream). They aren’t producing it, but they are profiting from it.

That’s definitely not the only vice that could keep you from investing in something as seemingly harmless as the hospitality industry. The economy is a web, and companies are often linked together in several ways.

Essentially how bad does a company need to be before you start getting uncomfortable? Again, there’s no universal right answer, but the stricter you want to be, the more limited your investment opportunities become.

Another option to just excluding all “bad” companies is to increase your exposure to the “good” companies. You can find funds that approach this from either direction.

Your Investment Approach

After you decide on your criteria, you still have to decide how to implement your socially responsible portfolio. There are two main approaches that you can use:

  • Invest in SRI funds
  • The True-Up Method

Invest in SRI Funds

Investing in SRI funds is the typical way to approach the problem. You find the SRI funds that best fit your criteria, then you build a portfolio from them.

But there are a couple of issues to consider here, the first of which is purely investment-related. Because you are limited to SRI funds that fit your criteria, you have a pretty limited pool to pick from.

When you’re seeking a fund that fits some criteria other than expected returns, it can be easy to forget that expected returns should still be one of your top factors. Just because a fund fits your social criteria doesn’t make it a good fund. Make sure it checks the rest of the boxes as well.

Just like any other fund you invest in, you want it to be a low cost, passively managed fund that has proven it can live up to its promises. Otherwise, you could end up investing in a bad fund just because the managers believe the same things you do.

There is also a chance SRI could limit your options to the point that you are not able to build an effective, globally diversified portfolio from the funds that work for you. You may need to decide between leaving out important asset classes, or using a traditional investment portfolio.

The other issue with the traditional SRI approach is that it doesn’t really provide any benefits to the causes and organizations that you care about. In addition, as we saw in part one, choosing to exclude (or overweight) certain companies is not going to affect their business. Your investment choices help you feel better about your portfolio, but the benefit ends there. But to be very clear, helping you feel better about your portfolio is important if it can help you stay disciplined.

The True-Up Method

Another approach that can potentially provide a better outcome for both you and the organizations you believe in is called the “true-up method.”

Instead of investing directly in SRI portfolios, you invest in traditional investments, but every year you compare your investments to how an SRI portfolio would have done. Anytime you did better than the SRI portfolio, you “true up” – donate the extra to a charity you care about. This does a couple of things:

  • It guarantees you can create an effective, globally diversified portfolio that takes the amount and type of risk appropriate for you.
  • By making donations to charities you care about, you are able to support your causes rather than simply avoiding the companies you don’t like.
  • Because those donations are charitable giving (rather than simply foregone returns like in a traditional SRI portfolio), you can deduct them from your taxes. Depending on the size of the outperformance, this can add up to a significant savings for you.

However, for all of the benefits of this approach, you would have to invest in the “bad” companies. If you can live with that, then there are real benefits to both your wallet and your causes. If not, then this is not the route for you. You want to choose the approach that will help you stay the course.

Socially responsible investing can be a valuable tool, but it’s important to keep the costs in mind. The expected return of an SRI portfolio is lower than the expected return of a comparable traditional investment portfolio.

I’m not saying you should avoid SRI. I would just encourage you to look closely at your options. If you do decide to pursue a socially responsible portfolio, you want to make sure you do it right.

Disciplined investing is the key to a good investment experience, and anything that helps you stay disciplined is a good thing. If you want to discuss how you can use SRI in your portfolio, drop us a line.


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