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Public companies sell shares of stock as a way of raising capital. So when you buy individual stocks or put your money into investment funds, you're indirectly funding their business goals. Socially responsible investing involves being strategic about where you put your money and investing in companies that share your values.
Just like traditional investing, socially responsible investing can help build your nest egg over time—it just focuses on companies that align with your moral compass. Socially responsible retirement accounts allow you to financially prepare for retirement without having a guilty conscience about where your money came from. Here's an overview of how it works.
What Is a Socially Responsible Retirement Account?
Socially responsible retirement accounts are investment accounts that include companies and industries you believe in and exclude those that aren't in line with your values. For some, that might mean avoiding investing in companies that engage in harmful environmental practices or have a historically racist or sexist work culture (even if it means sacrificing returns).
ESG investing, which prioritizes the environment, social issues and corporate governance, is one approach to socially responsible investing. Other socially responsible investment practices prioritize gender diversity, climate change, anti-violence and a whole host of other causes. Faith-based investing, for example, avoids companies that distribute products or services that go against the investor's religious principles. In other words, this type of investing comes in all shapes and sizes.
Choosing a Socially Responsible Investment Account
Look at Your 401(k)
A defined-contribution (DC) plan, such as a 401(k), could double as a socially responsible investment account. See if your 401(k) allows for a brokerage window, which is a self-directed option that lets you choose a wider range of investments, including socially responsible assets.
There's been some recent turmoil in the 401(k) space as it relates to socially responsible investing, however. A 2020 rule approved by the U.S. Department of Labor barred fiduciary plan managers from assuming extra investment risk or sacrificing potential returns in the name of nonmonetary factors—such as social responsibility. But the government body reversed course in 2021, saying it wouldn't enforce the rule and has since issued a proposal to overturn it altogether.
Open a Socially Responsible Individual Retirement Account (IRA)
IRAs make for great long-term savings vehicles that also provide nice tax advantages. You can include socially responsible funds and investments yourself, or opt for a professionally managed IRA. Alternatively, you can open an IRA with a robo-advisor to select investments that gel with your morals.
ESG-themed mutual funds, exchange-traded funds (ETFs), index funds and individual stocks can all make their way into an IRA. With regard to the latter, you can view companies' ESG ratings through investment research firms like Morningstar.
Another option is exploring socially responsible mutual funds and ETFs through a brokerage. These are baskets of investments that allow you to buy small shares of a variety of assets. This provides diversification and can help mitigate risk. It also makes things easier because only companies that have good ESG ratings are included.
Fidelity, Merrill and Charles Schwab all offer values-driven funds. Just be sure to pay attention to fees. At the end of 2020, average fees for sustainable funds were 0.61%, compared with 0.41% for traditional funds, according to Morningstar data.
Pros and Cons of Socially Responsible Investing
- Knowing you're supporting companies that share your values.
- Belonging to a community of like-minded investors.
- Potentially securing better returns. In 2020, U.S. sustainable equity funds outperformed traditional funds by 4.3 percentage points, according to Morgan Stanley research.
- You may have limited investment opportunities or struggle to find investments that align with your values.
- Vetting companies may add an extra layer of complexity to your investment approach.
- Returns are never guaranteed.
The Bottom Line
Socially responsible retirement accounts can help you grow your nest egg while also doing some good. No matter what, you'll want to make sure you're on solid financial ground before dialing up your investment game. You can do this by making sure your financial obligations are handled, building a strong emergency fund and paying down high-interest debt. Experian's free credit monitoring can help you manage your credit along the way.