If you believe in a cause, you should support it with your money, right? Well, that’s the basic idea behind impact investing. It’s investing in companies you believe are doing good things—all while trying to earn a profit. In other words: Putting your money where your mouth is.
Or, in the case of a group of tech billionaires who invested in a company that saves trees by making toilet paper out of bamboo, putting your money where your keister is!
But impact investing is more than just cutting a check to your favorite charity, because you also want to earn some cash on your investment.
According to the Global Impact Investing Network (GIIN), “Impact investments are investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.”1
The key here is that impact investors are looking for measurable positive impacts. Yes, investing in a company working to curb hunger might give you some warm fuzzies, but impact investors want to see real, measurable change—and sometimes this comes at the cost of lower profits. Profit is not the top priority.
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Not a tech billionaire? That’s okay. We don’t own a private island either. But if you are investing for retirement, it’s worth asking: Is impact investing right for me?
What Is an Impact Investment?
An impact investment aims to benefit society and provide a profit for the investor by investing in companies, organizations and funds that are aligned with certain issues, causes or values. Think of it as a middle ground between traditional investing and charitable giving where you can match your investing with your beliefs. You might also hear impact investing lumped into the category of value-based investing.
You can invest to make an impact on all kinds of social or environmental causes: reducing pollution, feeding the hungry, funding minority-owned businesses—the list is endless.
You might have heard impact investing used interchangeably with two other investment strategies: environmental, social and governance (ESG) and socially responsible investing (SRI). We know. It’s confusing. But let’s take a look at these strategies.
What Is Environmental, Social and Governance (ESG)?
So how do you know if a company is walking the talk? That’s where environmental, social and governance (ESG) criteria come into play.
ESG measures three aspects of a company (and we’re keeping this simple):
- Environmental: How environmentally friendly is it and how focused is it on sustainability?
- Social: How ethical is it in its treatment of employees, suppliers and customers?
- Governance: How transparent are its business practices? Is its leadership pushing positive change?
Several independent research firms evaluate companies and give them ESG rankings based on the criteria above, and they also look at how ESG drives profitability. We won’t get lost in the weeds talking about specific ESG rankings because each research firm has its own system. But ESG is definitely something to look for when you’re evaluating a company or mutual fund.
What Is Socially Responsible Investing (SRI)?
Socially responsible investing (SRI) focuses on an investor’s personal, political or religious values and incorporates ESG rankings. In some circles, SRI has come to stand for sustainable, responsible and impact investing. So it kind of serves as a broad term that includes impact investing.
Once again, the focus of SRI is social change while earning profits, but sometimes being socially responsible also means actively avoiding some companies. If you’re passionate about gun control, you probably won’t want to invest in a fund that includes a firearms company.
How Does Socially Responsible Investing Work?
First off, we never recommend investing your hard-earned money in single companies or stocks. When your retirement is on the line, you want to diversify by investing in mutual funds.
SRI used to be kind of on the fringes, but it has grown substantially in the last few years. Roughly $17.1 trillion is currently invested using socially responsible strategies, which represents about a third of all professionally managed assets in the U.S.2 That’s trillion, with a “T”! Climate change is by far the most important issue for investors.3
In reality, impact investing really isn’t all that different from investing in traditional mutual funds—the biggest difference is what the fund’s goals are.
For example, let’s say you’re passionate about providing access to technology to low-income neighborhoods and want to invest in companies dedicated to that cause.
You’d start by finding a mutual fund that includes companies that provide access to technology for folks in those communities. When you invest in that fund, you’ll be supporting those projects and companies that specialize in that particular cause. Pretty straightforward, right?
If there’s a particular issue that tugs at your heartstrings, there’s probably a fund somewhere out there that invests in companies trying to tackle that issue. Some of the common areas of interest include:
- Sustainable trade
- Low-income housing
- Carbon emissions
- Clean energy
- Toxic emissions and waste
- Clean drinking water
- Health and safety of employees
Now, there are hundreds of different mutual funds to choose from. So how do you know which funds might actually be good to add to your portfolio? You’ll want to sit down with an investing professional who can help you go over your options. That’s always a good idea, no matter what you’re investing in.
Does Impact Investing Really Work?
Just because a bunch of your well-meaning friends are diving into the world of socially responsible investing doesn’t mean it’s the right choice for you. Let’s dig a little deeper.
Like we mentioned earlier, socially responsible investing has two goals: to make a difference in the world and to make the investor money. So how does impact investing work for both sides? Let’s take a look.
1. How do SRI funds perform?
Well, it depends. Some impact investment funds intentionally invest knowing they’ll get lower returns. That’s because they’re more concerned with accomplishing their social or environmental goals than returning a profit. Other SRI funds bring in returns that are competitive with the stock market.
According to the Morgan Stanley Institute for Sustainable Investing, funds focused on ESG factors outperformed traditional funds by 4.3% in 2020.4 That hasn’t always been the case with these funds, but as they’ve grown in popularity and acceptance, profitability has increased.
2. Does SRI really make a difference?
The jury is still out on this. While it’s pretty easy to measure how funds perform financially, it’s a little trickier to evaluate how much they actually make a difference for the causes. Too often, investors are left guessing and hoping their money is being invested in companies and causes that are doing some good.5 That’s easier said than done.
Here’s the deal: Impact investing is still pretty new and, in many cases, there’s very little accountability and no standard to measure progress against. A company might say it’s taking steps to clean the environment, but who’s making sure it delivers on the promises?
The good news is that companies and fund managers are beginning to catch on. Many companies are starting to self-report on their efforts to have a positive impact on the environment, social causes and culture overall. So that’s progress!
Listen, we do believe that SRI can do some good. But it’s hard to measure how much good it’s actually doing. If you’re going to invest in SRI funds, you need to make sure you understand how your money is going to help the businesses you invest in and how they, in turn, will make the world a better place.
Should I Dive Into Impact Investing?
This is your money. These are your values. At the end of the day, it’s up to you to do your homework and decide whether or not to invest based on your values and principles. No one can make that decision for you!
Here’s what we will tell you: If you don’t understand it, don’t invest in it. Make sure you feel comfortable investing in something before you hand over your money. If some fund manager can’t tell you how your money will make an impact or give you a return on your investment, it’s probably not worth the trouble.
For those who want to make a difference, there are some alternatives to impact investing you should consider—like investing the old-fashioned way and making room in your budget for charitable giving or saving with the intention of giving to causes and organizations you care about down the line. You could even do both!
We want your investments spread out evenly between four types of mutual funds: growth, growth and income, aggressive growth, and international. And look for funds that have a long history of strong returns (think 10 years or longer).
Find a Financial Advisor
Okay, we can’t begin to stress how important it is to work with a financial advisor. It doesn’t matter if you’re just starting out or if you’ve been investing for years. Having a pro on your side to help you make confident decisions about your investments is always a good idea!
Need help finding a qualified investing pro? Try our SmartVestor program. With SmartVestor, you can find financial advisors who understand your goals and help you make sense of all your investing options.