When you think of investing, you might envision contributing part of your paycheck to a 401(k) or an IRA, or buying individual stocks and ETFs—and you wouldn’t be wrong. But investing can have more intention behind it than simply putting money to work toward future goals. ESG (environmental, social, and governance) investing—sometimes called sustainable investing—is all about aligning your money with the greater good, and investing with a focus on values and ethics.
What is ESG investing?
ESG investing allows you to put your money toward companies that score high on ESG ratings—a concept that’s been around for less than two decades. A company’s ESG score is based on its perceived impact on the environment, social causes, and other progressive issues.
When you invest in an ESG fund or a company with a high ESG score, you’re putting your dollars behind a company that’s theoretically helping address environmental and social issues. Here are ESG’s three components:
- Environmental: How a company affects the planet through its greenhouse gas emissions, renewable energy use, and the sustainability of its products and services.
- Social: How a company affects people (such as employees, customers, and the surrounding community) through factors like wages, employee safety policies, and its mission.
- Governance: How a company’s leaders and board function, including their ability to promote diversity in leadership, responsiveness to shareholders, and enforcement of ethical business practices.
Investment in ESG funds has seen steady growth over the past few years—investors contributed $51.1 billion to sustainable funds in 2020, up from less than $5 billion five years ago.Disclosure 1 The events of 2020—including a global pandemic, a political focus on climate change, and racial and civil unrest following the murder of George Floyd—also played roles in increasing interest in ESG investing.Disclosure 2 According to 2020 data from Morningstar, investors can now choose from more than 600 ESG funds and exchange-traded funds (ETFs).Disclosure 3
The mental and financial benefits of ESG investing
When your actions—or in this case, your investments—align with your values, you feel a greater sense of inner peace. That peace contributes to a more positive mindset and improved well-being.
When you use ESG investing to make your portfolio more ethical, you can feel good knowing that your financial resources are more likely to be helping companies that are working for the greater good.
Beyond helping to improve the world’s future, there are tangible benefits to ESG investing—you don’t necessarily have to sacrifice high returns when investing according to your values.
“If done right, I don’t think it’s an either/or,” says Brian Ford, head of financial wellness at Truist. “I think there are lots of really good companies doing really good things that can fit into most people’s value sets that will also provide good long-term returns.”
Research has shown that total returns of sustainable mutual funds and ETFs are similar to those of traditional fundsDisclosure 4—so your ESG investments could perform like your other investments.
Plus, companies with strong ESG track records showed lower volatility than their non-ESG counterparts during the COVID-19 pandemic.Disclosure 5 So, if you had investments in sustainable companies in 2020, they probably fared a little better than more traditional investments.
Are there risks to ESG investing?
It doesn’t matter how you invest—there’s always some level of risk. And while there are several perks to ESG investing, there are some unique potential risks to it, too.
- Long-term data doesn’t exist yet: While the first sustainable mutual funds were created in the 1970s, sustainable investing has only become widely popular in the last decade.Disclosure 6 The data just isn’t there yet to confirm that companies’ efforts are as effective—or that ESG investing is as successful—in the long term.
- Companies can stop reporting: While there are some regulations in place to protect people and places from companies, there aren’t any global standards. Companies can cherry-pick which stats make them look good, or they can choose to stop reporting their ESG efforts altogether.
- Your emotions could rule your decision-making: Investing and emotions are like oil and water—they don’t mix. If you’re not careful, ESG investing could play an oversize role in your investment decisions, potentially leading you to choose poorly.
How is ESG investing different from traditional investing?
“Investing should always have a purpose,” says Ford. “It should mesh well with your values, and that’s where ESG investing comes into play.”
The difference between traditional investing and sustainable investing is your purpose: spending to make money versus spending to help effect long-term change. Both are guided by values—and ESG investing absolutely has a place alongside your other investments—but Ford cautions against letting those funds take up too much space in your portfolio.
“A financial planner can help balance ESG investing with all the other variables that are important to you so that you’re not just picking stocks, companies, and mutual funds that are solely based on ESG,” he says.
How ESG investing can help you make an impact
Unfortunately, there are some drawbacks to ESG investing. You won’t always have the facts about how effective a company’s ESG policies are, especially because there’s no global standard for measurement and some companies have greenwashed their practices.
The good news is, you can have a direct hand in calling on companies to be better. Consider:
- Avoiding investments in companies with values that don’t align with yours: By supporting those that do, you “vote with your dollars.” (This applies not only to investments but also to everyday spending.)
- Researching companies before you invest: Reports and third-party sources such as the MSCI ESG ratings and Glassdoor can help you figure out which companies are actually trying to create positive change, rather than paying lip service to the causes you care about.
Thanks to consumers pushing for better, large companies have become more socially conscious. And while it’s not realistic to wait to invest in companies until their practices are perfect, you can use your money to support those you think are on the right track.