Blog > Fintech Industry > A Guide to Socially Responsible Investing for the Fearless Advisor

A Guide to Socially Responsible Investing for the Fearless Advisor

Finance is an industry that’s in love with acronyms.

From FIFO to LIFO, IAR to RIA to IRA, and ARM to ETFs, it can be hard to break through the jargon and understand what anyone is talking about in a given moment without keeping Google at the ready.

Right now, there’s another acronym that’s driving interest in investing, but this one isn’t limited to board rooms stacked with financial professionals. Instead, this acronym is gaining momentum in the living rooms of average people.

We’re talking, of course, about ESG.

ESG isn’t a new concept by any means, but it’s gaining renewed traction and enjoying a renaissance. Some call it ESG, others call it impact investing, and still others talk about it with the term “socially responsible investing.”

If we expand on each letter in ESG, the acronym stands for investing that prioritizes issues related to the Environment, Society, and Governments.

Whatever phrase your clients use for socially responsible investing, if they’re interested in it, it’s an advisor’s responsibility to educate themselves so they can help their clients understand more than the buzzword.

Let’s define socially responsible investing and unpack the ways to fearlessly approach any conversation with clients curious about its place in their portfolio.

What is Socially Responsible Investing?

How do you define socially responsible investing? That may depend on who you ask.

Here’s a standard definition: Socially responsible investing is the practice of investing only in companies that make a positive impact, according to the worldview of a particular client.

The truth is that each of your clients may define socially responsible investments for themselves slightly differently.

Some clients may believe that socially responsible investing means that they don’t invest in stocks associated with gambling or alcohol.

Other clients may have an aversion to investing in companies who maintain a presence in certain countries across the globe, like those that have records of human rights abuses. Case in point: Some research supports that Apartheid in South Africa ended in part due to the divestment of foreign money in South African businesses in the early 1990s.

And at times, socially responsible investing can have a religious element to it.  For example, those who follow Islam may have a desire to invest in Sharia-compliant funds.

While the origins of ESG investing may never be known with complete certainty, there is some belief that socially responsible investing can be traced back hundreds of years to the money principles taught by Methodists—or go back even further to money management principles of Jewish people.

However your clients define it, it’s clear that socially responsible investing is on the rise. Inflows into ESG-focused ETFs in 2020 more than doubled, racking up more than $51 billion in net new money.

So, what should your response be to this movement?

It’s your job as an advisor to harness your clients’ desires and help them win with the way that they want to invest.

Even if you don’t personally see the benefit of a socially responsible approach to investments, if your clients want it, you have to guide them through the process and help them understand which decisions will benefit them the most.

That’s where Rational Choice Theory comes into play.

The Role of Rational Choice Theory in Socially Responsible Investments

When a client brings up a desire to invest according to their personal beliefs, two things become immediately clear: 

  1. They care deeply about the individual holdings inside their portfolio.
  2. They need to fully buy into the choices you make for their portfolio—together.

By introducing Rational Choice Theory into your discussion about socially responsible investing, you can win on both fronts.

First, you show that you care enough about your clients’ feelings that you would go to the effort to prepare an investment approach that aligns with their personal beliefs.

Second, you’re giving them an opportunity to commit to your recommendation and stand behind the investing decisions you make as a team.

But what is Rational Choice Theory? Here’s a quick explanation of how it’s used:

Individuals use rational calculations to make rational choices and achieve outcomes that are aligned with their own personal objectives… we know that when people are given a choice between option A and option B, they will always feel more confident in their selection instead of someone giving them one choice, yes or no.

Here’s how this can look for an advisor in their daily practice.

When a client comes to you asking about a portfolio that aligns with their ESG preferences, you can give them multiple options.

Show them their current portfolio side by side with the new, ESG-focused portfolio you would propose instead. You can compare the allocation differences, performance return expectations, estimated income, and even any differences in riskiness of the individual holdings.

Now, instead of giving them one option, you’ve given them two. You’ve armed them with knowledge and shown them a clear view of what a socially responsible investment plan looks like for their future goals.

When they make a decision, they’re truly making a decision—not simply agreeing to one option.

As a result, they’re more likely to stay invested in their plan and commit to it with their full being. Perhaps even doubly so, because it now aligns with deeply held personal beliefs.

You can even run the entire process through Nitrogen with our multiple portfolio proposal functionality.

Taking an Objective Approach to Socially Responsible Investing

Some advisors have commented that ESG portfolios are based more on feelings than facts. If that’s true, then that’s no way to build an investment portfolio.

After all, “trust your feelings” only works for Jedis.

Empowering your clients to invest fearlessly doesn’t mean asking them to ignore well-researched data and objective information.

It does mean that you give them all the information they could possibly want so they can know that they’re making investment decisions that they’re comfortable with and likely to remain committed to, even during market volatility.

Getting clients comfortable with their investments can mean something different for each client, just like ESG can have different applications for each person. But what doesn’t change is how presenting objective data can be the key to helping clients see their holdings in a holistic manner.

That presentation begins with alignment. When clients can see that their risk tolerance, portfolio risk, and risk capacity are all in agreement, they can start off with confidence before you ever get to explaining the individual securities they might hold.

After that foundation setting, it’s easy to answer specific questions a client might have about individual holdings by using tools like Heatmaps to analyze the diversified risk of a portfolio and best case and worst case expectations for the holdings a client may want to choose to replace any previous holdings they no longer want to own.

The Responsible Approach is to Create Well-Educated Clients

Some advisors today are choosing to base their entire business on socially responsible investing principles, including only offering ESG-compliant portfolios to their clients.

Other advisors still might believe that ESG is another fad that’s making a return in the news headlines, only to fade away in a few years time until it reappears again later on.

Whatever your position, the right approach for each client you serve may look different. The responsible approach to socially responsible investing for financial advisors is to understand its role in a diversified portfolio and listen to client concerns.

Once an advisor has a firm grasp on the subject matter, they can educate clients with sound, objective financial advice.

From there, advisors can be the guide their clients need to realize their investing goals, while investing for those goals in a way that supports their personal belief system.

Need help getting alignment on investment decisions with your clients? Schedule a tour of the Nitrogen platform to learn how you can help clients commit to confident investing.

Share This Story