March 21, 2011 — 9:48am

So let’s say you’ve got some money you’d like to put to work in a socially responsible investment.  Maybe you received a bonus at your job, maybe you inherited some money from a relative or maybe you’ve just been diligently saving over the past few years and want to earn more than the pitifully low interest rate your savings account is currently paying.

Like many other aspects of your life, you want this investment to reflect your values when it comes to social and environmental responsibility.  So you’ve done some research and have read good things about a certain solar company — maybe a friend has invested in this company or maybe a green investment blog has mentioned it as a hot stock to own.  You believe the future is in renewables and solar power will play a major role in transitioning our energy grid away from a reliance on fossil fuels.  So you take your savings and invest it all in this one solar stock.

Good idea?

Probably not.

Here’s why:

By investing your life savings into one stock, you are essentially risking your financial future on the performance of that specific company.  What happens if the renewable energy sector underperforms, like it has over the past few years?  What happens if this particular company gets undercut by a Chinese competitor and loses market share?  Or what happens if an emergency crops up and you need immediate access to your savings?  If you’re forced to sell when the stock is down, you may end up taking a loss.

Just because you want to be socially responsible with your money doesn’t mean you should ignore the fundamentals of investing.  All the old rules still apply.  So what are these rules and how should you apply them to a green portfolio?

1. Diversify. By investing your savings into one stock (like in the example above), you’re opening yourself up to a huge amount of risk.  A diversified portfolio will help mitigate this risk.  Instead of investing in one company, spread your money across several.  And don’t just stick to solar stocks, or stocks in general, a diversified portfolio should have a mix of many different types of investments: stocks, bonds, CDs, some commodities and maybe even real estate.  Mutual funds or ETFs (exchange traded funds) are often a good way to get diversified, as each fund share typically invests in dozens of different stocks or bonds.

2. Risk tolerance. If you’re new to investing, it’s important to have a handle on your risk tolerance.  Stocks tend to be riskier than bonds, so if you prefer to stay on the more conservative side of things, stocks should only be a small portion of your overall portfolio.  One rule of thumb in the investment world is for an investor to have bond exposure equal to their age.  So, if you’re 25 years old, 25% of your portfolio would be invested in bonds.  75 = 75% in bonds.  The thinking being that younger people can afford to take on more risk than those folks closer to (or in) retirement.  Of course, everyone is different, and this rule generally applies to long term investing.

3. Time horizon. It’s also very important to know what your time horizon is – ie when you’ll need access to your money.  If you’re investing with a specific short term goal in mind (1 year or less), it doesn’t make sense to put your money to work in high risk investments like stocks since they may lose value and you’ll be stuck taking a loss when you sell.  If your time horizon is longer, let’s say you have a retirement account you don’t plan to tap into for 20 years or more, you can afford to take on more risk and volatility that comes with exposure to stocks, commodities and real estate.

4. Emergency Fund. To avoid a scenario where you’re forced to liquidate your portfolio before you’re ready (you lose your job, there’s a medical emergency, a family member needs help, etc), you should have three to six months of living expenses set aside to cover any unforeseen events.  It’s important to note that this account should be in cash, not CDs, since there are potential penalty fees if you need to sell out of a CD before maturity.

5. Keep Track of Your Investments. Even if you’re working with a professional advisor, it’s important to keep a close eye on your portfolio.  You should plan to review your holdings at least once per quarter.  Life events as well as market events can often impact how you will invest going forward.

If you incorporate these 5 rules into your investment approach, you should be well on your way to establishing a portfolio that is not only socially responsible, but financially responsible as well.