Making an Impact with your Investments while Achieving your Financial Goals
I'll be honest - I didn't always give thought to the social impact of my investment choices. Like many people, I'd spend a couple minutes reading through the investment options available on my 401k, look at historical returns, and make my selections.
But then I'd turn around that same day and spend half an hour in front of the laundry detergent aisle at the store researching surfactants to find the most eco-friendly brand.
How is it that I cared about being a conscious consumer, and yet I paid no attention to where I was investing my life savings?
Now, I don't think any of us would walk into town with our life savings and say - hey, I'd like to buy a stake in that supplier for migrant border detention - but that's exactly what we're doing when we invest our retirement funds into a US large-cap index fund.
There's a disconnection we feel with our investments. It's funny money, and who really has time to look through the hundreds or thousands of companies in our portfolios. Plus, we don't want to lose out on returns when we've worked so hard to earn those savings.
3 reasons to start investing with a lens on impact
Firstly, let me quickly dispel the myth that sustainable investing comes at the expense of investment performance. This chart shows that worldwide, ESG-focused companies (ESG = environmental, social, and corporate governance) have not only seen higher returns in recent years, but also stronger earnings and dividends. And it makes sense - what's sustainable can also be what's profitable.
Secondly, our investment dollars do matter. According to Nasdaq, retail investors like you and I own 77% of the US stock market capitalization. And let's set aside the moral high ground for a moment - from a purely selfish perspective, investing sustainably is good for us. Beyond achieving returns, it makes us feel good about where our money is going, which means we're more able to stick with our investments for the longer term, which we all know is the key to successful investing.
Thirdly, ESG has developed a lot over the last decade, and there's a lot of easily accessible sustainable investing options out there. That said, you want to be thoughtful about how you implement. If you just sprinkle an ESG fund here or there, you run the risk of pushing your portfolio into too much of an asset class or sector. That could drastically alter the risk/return profile of your overall portfolio.
Most of us are already conscious consumers. We realize that when it comes to laundry detergents and the products we buy, we have a choice to put our money where our values lie. The same is true of investing. We have a choice. And when we choose to be conscious investors - it's not only good for the world, it's also good for our wealth.
So how do you implement a sustainable investment portfolio?
Begin by understanding your motivation and identifying your values. Is your primary motivation to ensure that your investments are consistent with your beliefs, or is it to actively make a positive impact through your investments? Which causes are most important to you? Conversely, which types of companies are involved in activities that you strongly oppose? When I work with clients, I have them take an investing values questionnaire to help uncover these answers.
Understand the different ways you can incorporate sustainable investing strategies into your portfolio. At a high level, these include:
Exclusionary investing: “I want to screen out companies or sectors that do not meet my criteria.” This is where you avoid specific categories of stocks that don’t fit your values - tobacco or weapons, for instance.
Sustainability integration and inclusionary investing: “I want my investments to take into account ESG factors when considering risk and returns.” Now that ESG data has become far better - sources may include company filings, NGOs, government, and media - this type of investing has become much easier to implement.
Impact investing: ““I want to invest in companies that are working on delivering a measurable impact alongside financial returns.” An example is investing in an alternative energy fund that holds companies focused on reducing the use of fossil fuels. Another example is investing in a Community Development Financial Institution (CDFI) which provides business loans to low-income communities.
Sustainability-focused shareholder activism: “I want my fund managers to take an active role in pushing companies to adopt sustainable practices.” Given that investment funds are often amongst the company’s largest shareholders, there is an opportunity to use that influence - which is fueled by your investment dollars - to advocate for change.
Your portfolio may include one or many of these strategies to deliver on your objectives. And note that even with a sustainable portfolio, you can keep your investment expenses reasonable by using a mix of passive and active funds.
Understand the limitations of socially responsible investing and make sure to avoid these pitfalls
The data for ESG is getting better, but inconsistencies and potential biases are still a problem. As an example, Tesla receives an A ESG rating from MSCI while according to Sustainalytics, it has a “High Risk” ESG rating and ranks in the bottom third of the automobile industry. Beware also of “greenwashing” - this is when the financial industry uses marketing hype to make an investment product look more sustainable than it actually is. As a first step, you can read the fund’s prospectus to understand its objectives and assess for yourself whether it’s aligned with your values.
A company that scores highly in one area that you care about may score terribly in another. As an example, companies in the alternative energy sector tend to score terribly on women in leadership. Like most things in life, designing a sustainable portfolio is about tradeoffs. You will need to decide which values and objectives are most important for you.
Be careful not to put the cart before the horse - for most investors, delivering on financial objectives is still the primary goal. Because ESG and impact investments often favor particular sectors, geographies and styles - if you’re not careful, you can end up pushing your portfolio out of line with your risk/return profile. A financial advisor experienced with sustainable investing can help you design an investment portfolio that is aligned with your values and delivers on your financial goals.