The Modern Portfolio Theory (MPT) emphasizes that diversification is critical for minimizing your risk exposure. Diversification is a core value in successfully investing and it is no different for socially responsible investments (SRI).
The value of diversified asset allocation
The importance of diversifying your asset allocation is absolutely critical in effectively managing your portfolio’s risk. The types of assets you include in your portfolio, such as stocks, options, bonds, real estate, and businesses, determine how your overall net worth is impacted by market changes.
You want to diversify across various industries and instruments that do not react to market changes in the same manner. The more your investments do not correlate, the lower your long-term risk exposure becomes. The same principle holds true for your socially responsible investments portfolio.
Diversifying across SRI asset classes
Although sustainable investing may not provide a socially responsible investor with the complete array of financial instruments, there are still a myriad of options that allow for proper diversification through asset allocation.
ETFs have been introduced as an additional socially responsible funds alternative financial instrument. In addition, socially responsible investors always have the option of conducting their own research in finding socially responsible stocks.
Remember, social investing itself is not a diversification technique, but simply a screen to filter investment choices. It is important that you split your sustainable investing portfolio into the different asset classes, which provides you with risk balance.
A socially responsible investment fund is tremendously diversified, and you have the benefit of fund managers who actively monitor and manage the fund. However, you must have a minimum investment amount to purchase into the fund. The downside to this asset class, however, stems from the fact that it is very cost-prohibitive for you to leave the fund. If the socially responsible fund does not perform well, your liquidity for selling is also limited. Thus, SRI mutual funds are generally considered a good long-term investment, as they have the strongest upside potential ratio.
Socially responsible investment ETFs, on the other hand, provide you with diversification, but give you the ability to buy and sell at your discretion. Therefore, if you see your SRI ETF declining in value, you have the option of getting out at any point during the trading day, as social investing ETFs are traded just like socially responsible stocks.
Choosing individually screened socially responsible stocks are the riskiest SRI asset class, and thus, this should comprise the smallest amount of your portfolio. However, this provides you with another level of asset allocation, as well as diversification into corporations not represented by the funds. In addition, with the increased risk arrives greater potential for reward. It is much more common for individual stocks to see social investing returns with annual percentage gains greater than either ETFs or mutual funds.
Each level of asset class for socially responsible investing portfolios delivers its own risk-to-reward ratio and SRI investment returns. However, to give your portfolio the greatest diversification, it is important to allocate your assets between SRI ETFs, socially responsible funds, and socially responsible stocks, as they each provide different SRI investment returns strengths in varying market conditions.