Investing is no longer solely about financial gains. You may also worry about where you are putting your money and how your investments can affect the environment.
Your investment options are a powerful means of driving positive change and making a real impact on our planet and society. This is known as sustainable or socially responsible investing, or ESG investing. ESG is an acronym that refers to a set of environmental, social and governance standards used by socially conscious investors.
This investment approach allows people to align their investment choices with their values. The allure lies in its potential to generate not only financial returns but also positive social and environmental outcomes, as it takes into account the environmental, social and ethical implications of investment decisions.
But what exactly is sustainable investing, and how does it differ from traditional investment strategies? Let’s take a look at sustainable investing, its fundamental principles and how it differs from traditional investment strategies.
What Is Sustainable Investing?
Sustainable investing combines financial goals with a desire to positively impact the environment and society. Unlike traditional investing, which focuses solely on profits, sustainable investing takes a more holistic approach, considering ESG criteria to promote long-term sustainability and resilience, addressing environmental and social challenges and reducing risks for the future.
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When you log into your bank account, how do your savings look? Probably not as good as you’d like.
It always seems like an uphill battle to build (and keep) a decent amount in savings. But what if your car breaks down, or you have a sudden medical bill?
At the heart of sustainable investing lie three core principles:
- Environmental sustainability. This aspect focuses on the impact of companies and their operations on the environment. Sustainable investors look for companies that prioritize environmentally friendly practices, such as reducing carbon emissions, conserving natural resources, promoting renewable energy and adopting sustainable waste management techniques.
- Social responsibility. Social factors encompass a company’s treatment of its employees, customers and the communities in which it operates. Sustainable investors seek companies that uphold fair labor practices, support diversity and inclusion, respect human rights and contribute positively to the communities they serve.
- Good governance practices. Governance criteria evaluate a company’s management structure and ethical standards. Sustainable investors favor companies with strong corporate governance, independent boards of directors, transparent financial reporting and ethical decision-making processes.
Sustainable Investing Strategies
Although sustainable investing shares the same end goal, not all investors share the same motivation – different investors have different driving forces. Here are some of the strategies that investors can leverage when investing sustainably:
Positive/Best-in-Class Screening
In this strategy, investors employing positive screening seek out businesses with environmentally sustainable operations, responsible labor practices and sound governance structures. The investors’ main motivation is to support entities that prioritize ethical and sustainable conduct while potentially benefiting from their long-term growth and profitability.
Positive screening entails thorough research and evaluation of a company’s sustainability track record, impact on the environment and commitment to social welfare. Investors may consider factors such as a company’s carbon footprint, water and resource management, waste reduction initiatives, employee welfare programs, diversity and inclusion policies, ethical supply chains and board diversity.
Negative/Exclusionary Screening
In negative screening, investors aim to exclude companies or industries from an investment portfolio based on their involvement in harmful or unethical activities. The aim is to avoid supporting entities that contribute to social or environmental issues. For example, investors might exclude companies engaged in activities like fossil fuel extraction, tobacco production, or weapons manufacturing.
In other words, negative screening reflects investors’ desire to disassociate from businesses that conflict with their values or have the potential to cause significant harm to society or the planet.
Impact Investing
Impact investing is about using your money to make a positive impact on the world. Instead of focusing on profits, impact investors seek opportunities that tackle social or environmental challenges.
They support projects, companies and organizations that strive to create real and measurable positive change while still aiming for financial returns. Impact investing allows you to invest with purpose, making a difference in the issues you care about and contributing to a better and more sustainable future.
For instance, an investor can choose to invest in a company that supports new business owners with loan options such as invoice factoring or personal loans. Invoice factoring, specifically, can help fund growth by allowing companies nearly unlimited access to capital without too many complications.
ESG Integration
In this approach, investors evaluate companies based on traditional financial metrics while also considering their performance on ESG criteria. Rather than using ESG criteria as a separate screening process, ESG integration incorporates these factors throughout the investment decision-making process.
ESG integration helps identify companies with better risk management practices, stronger ethical standards and a more sustainable business model, potentially leading to more informed investment decisions even as a beginner.
Sustainable Investment Options
Thanks to technology, finding the right ESG investment opportunities is very easy. For instance, apps like Ellevest, Wealthfron and IMPACT make it effortless to find and invest in companies whose values align with your own.
Here are some of the investment options to consider if you’re looking to start investing sustainably:
- ESG funds. ESG funds are mutual funds graded based on ESG principles. These funds invest in companies that have sustainable and positive societal impacts. Some ESG funds have a broad focus, while others are more specific. For instance, the SPDR S&P 500 Fossil Fuel Reserves Free ETF lets investors support companies that don’t have fossil fuel reserves.
- Sustainable stocks. Sustainable stocks are shares of companies that prioritize responsible practices, environmental stewardship and positive social impact. These stocks allow investors to align their portfolios with their values by supporting businesses committed to sustainability and responsible corporate behavior.
- Socially responsible funds. These funds are specifically designed to invest in companies that meet certain social or ethical criteria. A good example of a socially responsible fund is the iShares ESG Aware MSCI USA ETF (ESGU). It includes over 300 large- and mid-cap U.S. stocks chosen for their positive environmental, social and governance characteristics.
The Benefits of Sustainable Investing
Sustainable investing isn’t just about doing good; it can also bring real advantages for you and the world. Here are some of the benefits:
- Potential for strong financial returns. Sustainable investments can perform well financially, offering the possibility of solid returns and long-term growth.
- Risk reduction and resilience. Companies with strong sustainability practices may be better equipped to face environmental and social challenges, potentially reducing investment risks.
- Environmental stewardship. Sustainable investing helps protect the environment by directing capital to companies that prioritize eco-friendly practices and sustainable resource management.
- Ethical and transparent governance. Companies with good governance practices tend to be more accountable, reducing the risk of corporate misconduct and unethical behavior.
- Contributing to global solutions. Impact investing allows you to actively participate in projects and initiatives that address pressing social and environmental problems, making a tangible difference.
Potential Risks and Challenges
Despite all the benefits, sustainable investing also comes with some potential risks and challenges. Here are a few:
- Performance volatility. Sustainable investments may experience short-term fluctuations in performance, just like any other investment. Companies in certain sustainable sectors, like renewable energy, may be more sensitive to changes in government policies or market conditions.
- The complexity of ESG data. Assessing a company’s ESG performance can be complex and involve various data sources and methodologies. Investors should be cautious about relying solely on ESG ratings without understanding the underlying criteria.
- Greenwashing. Not all companies claiming to be sustainable are genuinely committed to responsible practices. Greenwashing occurs when businesses falsely portray themselves as environmentally friendly to attract investors.
- Market perception and liquidity. Some sustainable investments may have lower liquidity or face a perception bias in the market. This can affect their market value and make it more challenging to buy or sell shares when needed.
Conclusion
Sustainable investing is not just about making money; it’s about making a difference. These investments support initiatives like clean energy, education and social equality, making a positive impact on the issues we deeply care about. It allows you to stand up for what you believe in and support businesses committed to responsible practices.
Whether you are new to investing or an experienced investor, you can make a difference through your financial choices.
New York contributor Kiara Taylor specializes in financial literacy and financial technology subjects. She is a corporate financial analyst who also leads a group affiliated with University of Cincinnati that teaches financial literacy to Black students and helps them secure employment and internships.
