6 Steps for Adding Ethical Investments to Your Portfolio

“Greening” your portfolio without losing your shirt

By Leland B. Hevner, president of the National Association of Online Investors [www.naoi.org] and author of The Perfect Portfolio [www.perfectportfoliobook.com]

In the college classes I teach on personal investing I have recently had a lot of student interest in adding what has been termed “ethical” or “green” investments to their portfolio. I sense a growing concern about the environment and a desire by average investors to support companies that are contributing to cleaning it up.

In past years so-called green companies have been rather exotic investments that attracted little interest among the investing community and did not fare particularly well in a portfolio. As an ethical investor you essentially had to suffer for your beliefs. Fortunately this has changed. Now investing in green technologies can not only make you feel good, it can earn you substantial returns.

But, as with all investments you need to know what you are doing. There are a lot of bogus investment schemes for green technology in the market and there is no shortage of mutual funds that claim to be “green” but use the term very loosely and often inaccurately.

Here are six steps for ethical investing that will give you the satisfaction of promoting the health of the planet as well as the health of your portfolio.

1. Understand what green technologies are and the forces that move related investments

Green technologies have two main goals. The first is to provide products or services that reduce pollution and contribute to cleansing the earth’s atmosphere. The second goal is to reduce our economy’s dependence on oil and hence our dependence on foreign countries. To meet these goals, companies exist that develop, manufacture and maintain products in the areas of wind power, solar power, geothermal power, advanced battery technology and others. These are “green” companies.

The price of investments in the green sector responds to two main factors:

• The price of oil. When oil prices are high, green technologies thrive. When the price of oil is low, consumers will not bear the higher prices of energy from green technologies. Since oil is a limited resource and worldwide demand is growing at a rate that can only result in higher oil prices, the long-term outlook for green technologies is good.

• Government mandates and spending. As you probably know, the current administration is placing an emphasis on clean energy, and a significant amount of stimulus and grant money is flowing into clean energy development. This is another factor that bodes well for investing in green companies.

So the future looks bright for ethical/green investing. Now you need to know how to take advantage of this opportunity.

2. Use ETFs
Many people who have the desire to invest in green companies are stymied when faced with the daunting number of choices. This problem immediately goes away if you simply purchase an Exchange Traded Fund (ETF) that holds a broad range of companies in the field. An ETF is an investment that owns a bundle of stocks just like a mutual fund but can be traded just like a stock-a feature that is important, as you will learn below.

Examples of ETFs that track an index of green companies are provided below. Shown are the trading symbol, name of the ETF and 2009 year-to-date returns as of October 29.

• QCLN: NASDAQ Clean Energy + 22%
• PBW: PowerShares WilderHill Clean Energy + 12%
• PBD: PowerShares Global Clean Energy + 22%

With one easy purchase you can own a basket of green companies, and you can see they have fared well in 2009. Green ETFs dramatically simplify the process of including ethical investments in your portfolio.

3. Find, evaluate and select the “best” green ETF
Next, you should identify at least three green ETFs for comparison purposes before deciding on one to buy. Then create a worksheet for collecting data using these headings: Performance (year-to-date and one-year), Risk (in the form of standard deviation-the lower, the better), Average Daily Volume (beware of extremely low volume-look for at least 50,000 share traded daily) and Management Fees (the lower, the better). Any number of sites will give you the data you need. An example is www.morningstar.com. Complete your worksheet and select the ETF showing the “best” data. But you are still not ready to buy.

4. Use a price chart to buy
For the ETF you have selected access a 6-month price chart on the Web. Again, many sites will give you this, including the Morningstar site referenced above. Simply “eyeball” the price line on the chart and see if the price trend is up or down. You only want to buy the ETF if it is currently experiencing a price up-trend. Never buy if it is moving down. If the price is falling, continue to check back until you see the price in an upward trend.

5. Use a trailing stop to sell
When you buy the ETF, you must also protect yourself from the risk of owning it. Clean energy investments can be volatile. The simplest way to do this is to place a trailing stop on your order at the time of purchase. This is very easy to do using an online broker. Here’s how it works: Let’s say that you purchase 100 shares of PBD for $15 per share. At the same time you can place a trailing stop order at a specified drop amount to limit your risk. You enter a trailing stop that says you want out if the price drops by $3. Now, if PBD immediately drops to $12, your position is sold. But if PBD goes up, the trailing stop price goes up with it, maintaining the $3 drop specification. So if PBD goes to $20, your trailing stop automatically follows it up to $17. But if from $20, PBD goes down to $18, your trailing stop stays at $17. The beauty of a trailing stop is that it goes up but never goes down! In effect it limits losses but allows profits run. You are now protected from unacceptable losses, and your buy decision just became a lot easier.

6. Determine your green allocation
As a final step you must determine the allocation of your investment money to your green investment. Remember that even though your downside risk is protected by a trailing stop, this is still a volatile investment, so don’t commit too much of your money to it. Your allocation will depend on your risk tolerance, your outlook for general market conditions including the price of oil, your view of government actions related to clean energy spending and finally the strength of the price uptrend you viewed on the chart in Step 4.

Summary
In my book The Perfect Portfolio I show how to design an efficient portfolio using one ETF for each of the following markets as building blocks: Stocks, Bonds, Energy, Gold, Agriculture Commodities, Real Estate and Emerging Markets.

In honor of Ethical Investing Week I can confidently recommend another for your consideration-a “green/ethical” building block. The 6 steps listed above show you how to create, monitor and trade it to both maximize your return and limit your risk and, in doing so, contribute to the health of our planet.

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