Let\'s say you want to change the world, but you don\'t have a lot of faith in protest rallies or politicians. What can a normal person with a full-time job do to make our world a better place?

Socially responsible investing (SRI) just might be the answer. SRI allows you to express political and ethical views through the unlikely format of investing. At this concept\'s core are two competing styles. One style is exclusionary: you create a list of companies that you won\'t invest in for moral reasons, and exclude them from your portfolio. The second, more proactive style is inclusive. It involves selectively investing in companies that share your core beliefs or purposely investing in companies that violate them so you can become a shareholder and vote to change company policy.

Tutorial: Investing 101 For Beginner Investors

In this article, we well examine both approaches in detail. As we\'ll discover, only inclusive SRI has any real hope of effecting change, but both methods might make you feel a little better about where your money is going. (To learn more, see Go Green With Socially Responsible Investing.)

The Two Sides of the SRI Coin
Exclusionary
These practices are probably the most common approach, and simply involve not investing in companies that engage in undesirable social or ethical practices. Common SRI mandates include not investing in alcohol, pornography or tobacco. Other sinful targets include companies that manufacture weapons or those that have poor labor practices such as using child labor in developing countries. The only thing you need to do with this style of investing is compile a list of companies you want to avoid. This can be very time consuming and expensive if you need to purchase relevant data to make your decision. (To learn where to get that information, check out Data Mining For Investing.)

Inclusionary
Another common approach to SRI is called "activist" investing or inclusionary selection. This approach involves investing in companies that either:

  • Already support a desired social goal, or
  • Are violating a social goal.

By investing in companies that meet your desired ethical values, you are supporting their efforts by increasing their stock price. Conversely, by investing in companies engaging in undesirable practices, you establish yourself as a shareholder to which company management must answer. Therefore, through activist investing you can use shareholder rights to vote proxies in line with your goals and attend shareholder meetings to propose appropriate changes. (To learn more, see Knowing Your Rights As A Shareholder and Proxy Voting Gives Fund Shareholders A Say.)

The Merits of Exclusionary SRI
Unfortunately, there is little evidence that proves exclusionary SRI mandates have created any material changes, nor is there a theoretical basis to expect they will. Exclusionary investing is based on the concept that by refusing to invest in a given company, its stock price suffers as a result. Because executive and shareholder wealth is tied to price appreciation, the logic is that exclusionary SRI mandates will stagnate this appreciation and force companies to change their ways in the hopes of attracting more investors. The reality of the situation, however, is that it just doesn\'t work that way.

First off, simply not buying a stock doesn\'t necessarily mean its price will fall. If you really want to drive a stock\'s price lower, you will need to engage in short sales. Exclusionary investing can\'t really accomplish much in terms of pushing prices lower unless a huge portion of all market participants avoid a company. This has yet to be seen. Part of the problem is that non-SRI investors will see the company trading at a discounted value, and they\'ll see an investment opportunity. You also run the risk of a private equity fund taking the company over to unlock its value in the private market.

Additionally, even if exclusionary SRI mandates were able affect a stock\'s price, it would still be unreasonable to expect this to force change. It\'s a bit of a stretch to assume a tobacco or alcohol brewer will simply abandon its core business because its stock price isn\'t increasing.

Exclusionary SRI can also become a slippery slope, where you end up excluding an ever-growing number of companies from your portfolio. For example, hotel chains are innocent enough, but most of them sell pornography in their rooms and alcohol in their bars. If you expand SRI investing too far, you could end up excluding an entire segment of the economy.

Military weapons manufacturers are another prime example. Yes, you can refuse to invest in a U.S. defense company, but it is only making weapons because the U.S. government is buying them. The question becomes, is your problem with the manufacturer or the entire U.S. government? Again, depending on how far you want to take your exclusionary policies, you might not even be able to hold Treasury bonds, a staple of almost any investment portfolio. (For more on the importance of T-bonds, see our Money Market tutorial.)

Overall exclusionary policies really don\'t effect change. The benefit is that the investments will be aligned with your personal beliefs, which can let you sleep a little better at night. However, this is where emotion and ethics can supplant traditional investment logic and reasoning, as SRI investing can involve sacrificing investment opportunities in exchange for the satisfaction of doing the right thing. (To learn more, read Socially Responsible Mutual Funds and Go Green With Socially Responsible Investing.)

The Merits of Inclusive SRI
Unlike the exclusionist style, activist SRI mandates have a lot of merit and there is good reason to believe they can be employed to effect social change. Activist investing works by investing in (and supporting) companies that are in line with your social goals.

A good example is green tech companies that are working to provide alternative energy sources, or firms that treat their workers well or refuse to employ child labor. Additionally, by being active as a shareholder, you can directly effect change. Of course you need to have enough shareholders that agree with you for this to work. (To learn more about green tech companies, see Clean Or Green Technology Investing.)

The good news about activist SRI is there aren\'t really any inherent flaws in this approach. However, it can entail a lot of work to get things accomplished. Again, the free market economy has spoken in this regard and there are publicly traded mutual funds that will serve as activist investors on your behalf. They will vote proxies in line with stated SRI goals and will attend annual meetings to pursue their agendas. Even an individual with a modest sum of money can participate in these activities.

In fact, there have been some successful changes brought on by small investors. Sister Patricia Daly, a nun and executive director of the Tri-State Coalition for Responsible Investing, has taken activism to a new level by taking her small investments and heading up shareholder proposals to create corporate policy changes. For example, she has gone up against Exxon Mobil to get the large oil company to agree to set emission standards.

The Substance of Style
If you are someone who wishes to effect social change through your investments, it can be a daunting task. However, through the free market economy of the United States you can pool your money with other like minded investors through publicly traded mutual funds or even charitable foundations that employ SRI mandates.

It\'s important to remember that SRI may not always have a material impact on a company or increase expected investment returns, but you will sleep better at night knowing you\'ve satisfied your moral and ethical goals.

Related Articles
  1. Investing Basics

    Bill Ackman's 2 Best Investments (GGP, CP)

    Learn about the two best investments Ackman ever made. Ackman has demonstrated a consistent track record of success in all types of market environments.
  2. Investing

    George Soros: 3 Best Investments Ever

    Learn about some of the most successful trades famed investor George Soros has made during his career, including a billion dollar profit against the pound.
  3. Saving and Spending

    Where Does Bill Ackman Keep His Money?

    Learn about where prominent hedge fund manager Bill Ackman keeps his money. See how his short position in Herbalife has not been successful so far.
  4. Stock Analysis

    Elliott Management: An Activist Investor Analysis (HES, CTXS)

    Learn about the activist investor strategies used by Elliott Management. Read about the fund's positions in Hess Corp., Citrix and CDK Global.
  5. Mutual Funds & ETFs

    3 AllianceBernstein Funds that Are Rated 5 Stars by Morningstar

    Discover the top three mutual funds administered and managed by AllianceBernstein that have received five-star overall ratings from Morningstar.
  6. Retirement

    Is it Safe for Retirees to Invest in Technology?

    Tech stocks are volatile creatures, but there are ways even risk-adverse retirees can reap rewards from them. Here are some strategies.
  7. Mutual Funds & ETFs

    Is Morningstar’s Star System An Effective Ranking Tool? (MORN)

    Learn why Morningstar's star rating system is not always a great predictor of future performance, and why investors should not pick funds on star ratings alone.
  8. Stock Analysis

    The Top 5 Oil and Gas Stocks for 2016 (XOM, BP)

    Read detailed analyses of the top five oil and gas stocks, and learn why they may be poised to rise in 2016 after a dismal 2015.
  9. Retirement

    Roth IRAs Tutorial

    This comprehensive guide goes through what a Roth IRA is and how to set one up, contribute to it and withdraw from it.
  10. Mutual Funds & ETFs

    ETFs Can Be Safe Investments, If Used Correctly

    Learn about how ETFs can be a safe investment option if you know which funds to choose, including the basics of both indexed and leveraged ETFs.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is finance?

    "Finance" is a broad term that describes two related activities: the study of how money is managed and the actual process ... Read Full Answer >>
  3. What is securitization?

    Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming ... Read Full Answer >>
  4. What is the difference between positive and normative economics?

    Positive economics is objective and fact based, while normative economics is subjective and value based. Positive economic ... Read Full Answer >>
  5. Can hedge funds trade penny stocks?

    Hedge funds can trade penny stocks. In fact, hedge funds can trade in just about any type of security, including medium- ... Read Full Answer >>
  6. How liquid are Vanguard mutual funds?

    The Vanguard mutual fund family is one of the largest and most well-recognized fund family in the financial industry. Its ... Read Full Answer >>
Hot Definitions
  1. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  2. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  3. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  4. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  5. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
Trading Center