Values-Based Investing: How to Align Your Money and Principles

Values-based investing means making sure you aren't investing in companies that may conflict with your personal beliefs and values. But can it make you money?
Last updated Aug 7, 2020 | By Christy Rakoczy
What is Values-Based Investing and is it Right for You?

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When you first get started in the stock market or with other investments, obviously you want to make a profit. But for a growing number of people, maximizing their return on investment isn't their only concern. Many people, especially younger investors, want to make sure they aren't putting their money in companies that go against their personal values or that aren't good corporate citizens.

That's where values-based investing comes in. Values-based investing refers to the practice of looking beyond a company's balance sheet to also consider the economic and social impact a company and its leaders have.

There are a few different terms for these kinds of investment decisions, and some different ways to get started in practicing values-based investing. If you're interested in living out your principles by making sure your money isn't supporting companies you have fundamental disagreements with, it's important to learn the basics so you can pick a wealth-management approach that fits both your financial goals and your personal values.

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What is value-based investing?

Values-based investing is exactly what it sounds like: You select investments based on your values, not just on whether they're likely to turn a profit. For some people, the goal of doing this is to help ensure your money isn't supporting businesses that behave in ways you think are harmful. For others, the goal of building this sort of investment portfolio is to influence corporate behaviors and hopefully help businesses become better citizens.

There are actually three different terms for this type of investing:

  • Socially responsible investing (SRI): This involves avoiding putting money into industries that have negative environmental or social effects, such as companies that produce tobacco, defense companies, or those that damage the environment.
  • Environmental, social, and governance investing (ESG): This refers to making investment choices after considering each company's environmental impact, social impact, and corporate governance structure. Investors may look at executive pay, representation of women and minorities on the board, and a host of other issues.
  • Impact investing: This involves investing in companies with the goal of generating beneficial social or environmental change.

These terms are sometimes used interchangeably, though there are differences between them. Each strategy is popular among people who may not mind sacrificing some financial performance if their investments enable them to live their principles.

Value-based investing isn't a new concept. In fact, religious groups have a history that dates back centuries of shunning companies profiting from activities seen as counter to their beliefs. These activities have included slavery, war, gambling, alcohol, or other vices.

However, it wasn't until the 1960s and ’70s that more organized movements for responsible investing began to take shape. Shareholder advocacy became more common, with shareholders questioning Dow's production of Agent Orange and pressuring General Motors to put public representatives on the board of directors. And it wasn't until 1982 that the first fund — the Calvert Social Investment Fund — began screening for political and social issues such as human rights and environmental impact.

Values-based investing and investment products alike have come a long way since those early days. The 1990s saw new issues coming to the forefront relating to executive pay, minority representation on the board, and the treatment of workers in global factories. By the early 2000s, there were already more than 200 mutual funds performing social screening, and by 2016, more than $8.72 trillion was invested in sustainable, responsible, or impact investments.

Values-based investing also has ample room to grow, with 75% of all investors and 86% of millennials indicating their interest in sustainable investing. This is just one more way millennials are shaking things up when it comes to their financial management — a recent FinanceBuzz study revealed millennials are much more willing to break traditional money taboos than other generations.

The types of value-based investing

Socially responsible investing

Socially responsible investing is the broadest type of values-based investing. It involves looking at whether companies you're investing in behave in a socially responsible manner or have a positive impact on society. Employing this investment approach often means avoiding certain industries such as gambling, adult entertainment, nuclear power, tobacco, or firearms.

If you want to engage in socially responsible investing, there are a number of mutual funds or exchange-traded funds (ETFs) that enable you to do so easily. These funds pool your money with other investors and use the combined pot of cash to buy into companies that meet specific guidelines. In this case, these guidelines would include behaving in an ethically responsible way.

Some examples of SRI funds include:

  • SPDR S&P 500 Fossil Fuel Reserves Free ETF: This index fund aims to track the performance of the S&P 500 (a financial index made up of the 500 largest U.S. companies) minus any businesses on the index that have fossil fuel reserves.
  • TIA-CREF Social Choice Equity Fund: This fund evaluates which companies to invest in based on factors including climate change and corporate governance, while steering clear of investing in nuclear power, gambling, and tobacco, among other industries.

Environmental, social, and governance factor investing

This investing strategy focuses specifically on screening companies based on the following ESG criteria:

  • Environmental: Is the company a good steward of natural resources that aims to minimize its environmental impact?
  • Social: Does the company behave in an ethical manner as a good corporate citizen in its community and when managing its relationship with suppliers and customers?
  • Governance: Does the company have a diverse board of directors, reasonable executive pay, good internal controls, and strong shareholders rights?

Investors who are particularly concerned about the use of fossil fuels or renewable energy, equality and corporate governance, and human rights may be drawn to ESG investing. And just as with SRI, there are specific mutual funds or ETFs that provide the opportunity for ESG investing including:

  • State Street Global's Gender Diversity Index ETF: This fund focuses on companies that aim to advance women by ensuring their corporate boards have strong gender diversity.
  • iShares MSCI KLD 400 Social ETF: This fund aims to track the investment results of an index made up of U.S. companies with positive environmental, social, and governance characteristics.

Impact investing

With impact investing, the key is to achieve positive outcomes through your investment dollars. For example, the goal may be to invest in companies that benefit the environment or society, such as businesses that develop renewable energy or that aim to make education more widely available.

Investors who are less concerned about earning good financial returns and more concerned about helping to achieve good outcomes may be drawn to impact investing. The Global Impact Investing Network can help you learn more about what to look for in impact investing funds.

Pros and cons of value-based investing

There are both advantages and disadvantages to values-based investing that you need to consider.

The pros of value-based investing include the following:

  • You can live your values. If you believe strongly in your principles, such as protecting the environment, animal welfare, or equality for everyone, you may not want any of your investment money going to companies that behave in ways you feel are harmful. Values-based investing allows you to ensure that doesn't happen.
  • You can help to make an impact. With a growing number of investors engaging in values-based investing, companies that hope to grow may find themselves pressured to behave in more responsible ways.
  • Socially responsible companies often tend to perform well. Morningstar data found that sustainable investments generally perform well in terms of other metrics that are linked to long-term profits, such as having a strong competitive advantage. Morningstar also found that 41 out of 56 ESG indexes performed better than similar indexes that weren't focused on environmental, social, or governance factors.

But there are also disadvantages. The cons include the following:

  • It can be difficult to know whether businesses are upholding their values. With companies often self-reporting on their actions, it can be difficult to know for sure if businesses are living up to their promises.
  • Your investments may not perform as well. If you're not focused solely on the bottom line, your ROI may be lower because you aren't focused solely on your investment’s financial performance.
  • You may not be able to invest in ESGs in some retirement accounts. The Department of Labor has taken steps to restrict ESG investment practices in 401(k)s and corporate pensions because ESGs don't focus solely on the financial interest of plan beneficiaries and thus may be in violation of the Employee Retirement Income Security Act.

Bottom line

Investing is always a risky venture, so you'll want to do your due diligence before making any investment choice. That means not only considering whether an investment aligns with your values, if that's important to you, but also taking a close look at the potential impact of your investment choice. When it comes to how to choose a brokerage to work with, these considerations may also come into play.

The good news is, there are many brokers that not only make investing easy but also provide educational material to help you make more informed choices. You can review your brokerage firm's information on values-based investing to see whether it's right for you. Or you may wish to speak with a financial advisor if you have more specific questions about what investment strategy you should adopt when it comes to your long-term financial planning.

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