How to Do Socially Responsible Investing
Sometimes called ESG investing, it’s all about putting your money where your values are
The hottest trend in investing today, and one you may want to embrace if you haven't yet, is investing in ways that represent your values.
The practice is often called ESG investing (environmental, social and corporate governance), though some dub it socially responsible investing or, in certain cases, impact investing. Years ago, the name was "ethical investing."
Leading the charge toward socially responsible investing: women. A June 2022 survey by the financial research firm Cerulli Associates found that 52% of women would rather invest in companies that have a positive social or environmental impact; 44% of men felt that way.
"When we invest our money in the things that we care about, it makes our money more meaningful to us."
"Women want more than just financial return," Janine Firpo, author of "Activate Your Money" said on the Friends Talk Money podcast I co-host with Terry Savage and Pam Krueger. "We're realizing that when we invest our money in the things that we care about, it makes our money more meaningful to us."
Krueger, founder of the Wealthramp, a firm that vets financial advisors, says advisors tell her that "the clients who are asking these questions [about socially-responsible investing] are women." And, she adds, "lots of women who are close to retirement or already retired seem to want to make a difference with their money."
More Investments to Choose From
Investing this way is becoming much easier to do.
Every major mutual fund and ETF (Exchange-Traded Funds) company now sells ESG products. And according to InvestmentNews, a trade publication for financial advisors, U.S. mutual fund companies last year came out with 70% more of them than in 2020. Similarly, nearly two-thirds of new ETFs last year were ESG-focused.
Roughly two-thirds of financial advisors now use ESG products, InvestmentNews Research has found. A year ago, 59% did.
The Biden administration is expected to reverse the Trump administration's limits on ESG investing in retirement plans this summer, too.
That's apt to make it far more likely that your employer's 401(k) or 403(b) retirement savings plan will offer at least one ESG choice. Currently, according to a 2022 Bank of America study of the 3.1 million participants in the employee benefits programs it runs, only 11% of 401(k) plans offer ESG-focused funds to employees.
ESG Is Not Well-Defined
But investing to follow your values requires more than a little caution, especially if you're interested in buying an ESG mutual fund or ETF. That's because financial firms have a lot of leeway in determining what they mean by ESG investments.
For some funds and ETFs, it's about what they don't invest in. For others, it's about only owning stocks in a particular sector, like green energy. And for others, it's about holding stocks with top ESG ratings, though the data underlying ESG ratings, Kenneth Picker and Andrew King recently wrote in the Harvard Business Review, "are incomplete, mostly unaudited, and often dated."
Some critics have names for sales and marketing efforts that play fast and loose with ESG definitions: "doublespeak" and "greenwashing."
To clamp down on that, the Securities and Exchange Commission (SEC) has proposed rules restricting the use of the term "ESG" by fund companies and ETFs. SEC Chairman Gary Gensler has said: "What we're trying to address is truth in advertising."
The SEC is also expected to start requiring public companies to provide fuller disclosure about their environmental, social and corporate governance practices.
Keep in mind: your own definition of what might be good or bad for the planet might be much different than the one used by particular ESG fund managers and ratings firms and public companies.
It's also hard to know whether a company's self-declared ESG approach is actually working.
As Stanford finance professor Amit Seru wrote in The Promise and Pitfalls of Investing for Change, an article on the university's Graduate School of Business website, "Good luck measuring the impact of an investment on social or economic inequality. The data are messy, crude, and measured with a lag."
Advice for ESG Investing
So, before putting a dime into an ESG fund or ETF, read its prospectus and disclosure materials to see how that firm defines ESG. If you plan to buy a particular stock for ESG reasons, read its annual report and website to learn more about whether its values align with yours.
"You do not give up financial returns when you invest with your values."
Conversely, remember that just because a company is socially responsible, that doesn't necessarily make it a good investment.
Investing this way also can mean paying steeper fees than what you would pay to own traditional mutual funds and ETFs. In their Harvard Business Review article, Picker and King wrote that ESG funds typically charge fees 40% higher than traditional funds. That's not necessarily a reason to avoid investing in these funds, but it is something to consider when gauging your potential returns.
And that leads to the big question you may be wondering: Will I earn a better return with ESG funds and ETFs than with others? Possibly.
"There's been an enormous amount of research that's been done, and it shows unequivocally that you do not give up financial returns when you invest with your values," Firbo said on my podcast. "In fact, you can meet or even exceed the returns that you see in non-sustainable investing."
The key word there is "can."
A Rough 2022 for Many ESG Funds
Many ESG funds have had a rough 2022. Partly, that's because they often don't own any, or many, oil company stocks; that sector has performed well this year. Partly, it's because sustainable funds are often big owners of tech stocks, a sector that's largely been clobbered lately.
According to Morningstar, the fund and ETF research firm, 65% of sustainable U.S. stock funds are at the bottom of their category rankings this year. But over longer periods, most U.S. stock ESG funds have been in the top half of their categories.
The current trend toward ESG investing, however, could help boost potential returns. "As more investors demand socially responsible companies to be included in their portfolios, you could see a little extra push on those stocks as those stocks become in demand," Savage said.
Willing to Potentially Sacrifice Returns?
Regardless, you may be willing to sacrifice potential returns and accept higher fees in exchange for the feeling you'd get by investing with your heart as well as your wallet.
In fact, a 2021 Million Dollar Round Table survey found that 34% of Americans who use financial advisors said they were willing to accept lower investment returns if they could incorporate their personal beliefs into their portfolios.
For help assessing the climate and social impact of ETFs, mutual funds and 401(k) plan investments, the As You Sow nonprofit offers a free online analytic tool. There's also Carbon Collective, which has a three-step questionnaire to let you allocate funds to one of its "climate-forward portfolios."
And Savage suggests considering Newdayimpact.com, which runs six portfolios with assorted sustainable goals that let you focus on your impact priority, from clean water to climate action to animal welfare. Newday donates 5% of its net revenues to nonprofits working in the ESG field where you've made your investments, Savage says.