The Issue with Investing
Since the digital revolution, financial literacy and access to trading platforms has exploded, and investing in the stock market has become an actual possibility for most people. Trading apps and influencers market investing as a safe and easy way to make “passive income,” and in a way, they are right. The S&P 500, which tracks the stocks of the largest businesses in the United States, has historically averaged around a 10% return annually over several decades. However, as concerns about climate change, sustainability, and human rights grow, it is hard to ignore the personal moral dilemma of contributing your personal funds to a business with a negative environmental or social impact.
Business and manufacturing form the basis of the American economy. Yet, this sector contributes 30% of US greenhouse gas emissions, not even counting many of the indirect retail and transportations emissions businesses incur. Many businesses also treat their workers poorly and have been accused of contributing to systemic inequality. Some of the largest American tech companies like Apple, Alphabet, and Microsoft are facing ongoing human rights lawsuits. However, these same companies have provided consistent returns to investors in the long run.
Investing and stock trading remains a great way to build wealth, leaving individual retail investors like myself with an interesting challenge: Is there a way to structure your portfolio in a way that makes positive returns without compromising your personal values? In recent years, this problem has been addressed by the continued growth of impact investing, or the process of considering social benefit and environmental impact alongside traditional financial concerns when making investment decisions. This article explores what impact investing is and walks you through how any individual can create their own personal sustainable investment portfolio.
What is Impact Investing?
One of the biggest misconceptions about impact investing is that it is philanthropic, with funds being invested into sustainable industries solely for social or environmental reasons. However, impact investing is very much in line with traditional investing, with the expected return and risk of an investment being one of the primary concerns of an investor.
What makes impact investing different is that it also emphasizes aligning one’s portfolio with their personal values in order to only invest in securities that will provide positive social, environmental, and financial returns. How much an investor emphasizes non-financial returns varies on an individual level (see Figure 1), but in general, impact investors will screen assets like stocks for certain ESG red flags (high emissions, poor worker compensation) and personally decide whether they are comfortable owning that stock in their portfolio.
Figure 1: The Spectrum of Impact Investing
One way investors decide whether to purchase a stock or not is by examining its ESG score, which is determined by neutral evaluation firms. One of the most trusted is the MSCI index, which ranks companies from AAA to CCC, with AAA being the best. Another example is Sustainalytics, operating on a 0-100 scale with a lower number (<20) meaning a lower ESG risk to investors. Using these publicly available indexes, you could set a personal investing cutoff to filter companies by their ESG score. However, ESG metrics do vary a lot between institutions due to incomplete measurements, so always dig into annual reports, disclosures, and independent evaluations before investing.
Identifying the personal values and objectives that you want to base your impact-oriented portfolio off of is also key. Impact doesn’t just encapsulate sustainability; conservation, gender equality, poverty reduction, disability services, and renewable energy all fall under the impactful industry umbrella, to name a few. Deciding to focus on an industry that you feel a specific connection to or interest towards will help you narrow down the thousands of assets that could be considered impactful.
You should also consider why you are aiming to invest this way. If you solely want to avoid putting your money into harmful industries, you can invest in carbon-neutral companies with strict regulations. If you want to actively contribute to solutions, you can choose to invest in companies that are actively cleaning up oceanic plastic pollution or developing renewable energy solutions. And if you want to directly benefit the primary shareholder of an asset, invest in minority-owned businesses, small local businesses, or businesses in developing countries.
Once you identify where and why you want to invest your money, you can consider asset classes, risk tolerance, and other problems typical for traditional investors.
Typical Financial Considerations
It is very difficult to estimate future asset return over a set amount of time accurately, which is why all investments have a risk factor associated with them. Quantifying your own risk tolerance is tricky, but having a general idea of how risk averse you are can help guide investment decisions.
Holding an individual stock makes it easy to align your moral considerations with the stock of choice, but the return of a single asset is very uncertain. One of the easiest ways for an individual investor to reduce risk is to utilize pooled investment vehicles like Exchange-Traded Funds (ETFs), which essentially bundle many stocks into a single tradable asset (also known as an index) in order to reduce risk. Here are some of the most well-known impact-oriented ETFs:
- iShares Global Clean Energy ETF (ICLN) tracks companies in the clean energy sector.
- Vanguard ESG U.S. Stock ETF (ESGV) excludes companies in controversial sectors and favors companies with higher ESG scores.
- iShares ESG Advanced MSCI USA ETF (USXF) is similar to ICLN except for using stricter criteria for stock selection.
It is important to note that these ETFs vary in criteria and some hold a variety of companies including Tesla, Apple, and Microsoft, which have all faced ESG-related criticisms that may conflict with your personal values. Buying ETFs is easy, but you should do your own research to determine whether they actually contain stocks you would feel good buying on their own.
Individual investors can also use sector-specific ETFs to invest according to their goals. For example, Impact Shares YWCA Women’s Empowerment ETF (WOMN) only holds companies that work to advance gender equality. If you decided that you wanted to invest in the solar industry, the Invesco Solar ETF (TAN) mostly tracks global solar companies. In general, purchasing bundles of assets that each individually align with your personal views can be a great way to invest impactfully.
Building Your Portfolio
Once you’ve decided how much of an importance you want to place on impact, the types of companies you want to invest in, and your personal impact goals, all there is to do is create and monitor your portfolio. Buying your stocks of choice is easy through the many accessible trading platforms that can be accessed right from your phone, making your portfolio simple to monitor. Once your portfolio is set, be patient and let it grow. Short-term volatility is often accounted for by long-term consistent returns, and impact-oriented funds don’t differ in their long-term returns from non-impact funds. If you experience losses, most investors cut ties according to the 7% rule, which says to sell a stock if it falls 7-8% below the initial price you paid. By using strategies like this, investors can limit early losses and avoid finding themselves in a hole of sunk costs.
The most important thing to do when building a portfolio is to do your own research. The intersection between impact and finance can be murky, with companies taking advantage of gaps and inconsistencies in ESG guidelines to appear cleaner than they actually are. ESG scores don’t tell the full story of a company’s impact, but estimating it is a good first step towards being mindful about where you put your money. Know your investing goals and priorities, be thorough in your individual research, and don’t be afraid to be patient and let your portfolio weather short-term risk. Happy investing!
Reader Question
Have you ever considered the social and environmental impacts of companies whose equity you are directly purchasing? How can impact investing help bridge the gap between financial decisions and environmental/social responsibility?