What is ESG Investing and Why You May Want to Start
There’s been a large movement in recent years to begin purchasing more intentionally and supporting small businesses and companies that align with your ethics and values. Now, there’s a new investing movement designed to help support companies and startups that also align with your ethics — ESG investing.
ESG investing has gained a lot of traction lately and might be a smart way to diversify your portfolio. Not only has ESG investing become particularly important to young investors, it’s also been shown to yield high financial returns long-term.
- What is ESG investing?
- ESG investing vs. socially responsible investing
- The bottom line
What is ESG investing?
ESG stands for Environmental, Social and Governance. ESG investing allows you to take all three of these factors into consideration when choosing to invest your money, so you can support corporations and companies that are dedicated to causes you believe in.
The ESG investing movement has become more popular as millennials and younger generations have become interested in putting their money behind companies that represent their values and ideals. This type of investing might seem contradictory to common investing practices, but ESG compliant companies generally have good reputations and a proven track history of outperforming the market.
To better understand how ESG investment decisions are made, let’s first review the three main ESG considerations that comprise this investing type:
This next factor applies to a company’s dedication to environmental impact. This could include areas such as waste, energy use, recycling, conservation efforts, pollution, and even handling of animals. An investor might look at how a company is trying to make advances in any of these key areas or how it is mitigating environmental damage (such as properly disposing of hazardous waste or reducing pollution outputs) or focusing on climate change initiatives.
Next, investors look at social factors both inside and outside of the business when evaluating an ESG company. Social impact efforts could include community outreach and volunteer programs, fair and diverse hiring practices, and a general focus on human rights.
Lastly, investors will look at how a company’s governance factors. This area includes how a company is managed and the way the board makes decisions and reports to stakeholders. It could also include whether or not management is diverse and whether employees are paid fair and reasonable wages.
ESG-focused investors would perform an investment analysis using a company’s sustainability reports to determine ESG ratings across all three components, while also evaluating the company’s growth.
ESG investing vs. socially responsible investing
Socially responsible investing (SRI) and ESG investing are commonly mistaken for one another, because they’re both forms of sustainable investing. While ESG focuses on finding and buying into companies that have made progress in environmental, social, or corporate governance areas, SRI investing opts out of companies that do not support an investor’s values.
For example, an SRI investor might exclude any tobacco or weapon-related stocks if those products go against the investor’s beliefs. Likewise, an environmentally-conscious ESG investor might opt out of any stock relating to oil or other fossil fuels.
Both ESG and SRI investing tend to focus on the same social and moral tenants, but the approach is different. While ESG investing seeks out stocks from companies that stand out ethically, SRI investing seeks to exclude companies that stand out negatively.
Pros and cons of ESG Investing
It’s important to understand ESG risks and benefits before committing to a new portfolio type. While ESG investments primarily offer advantages, there are some disadvantages to keep in mind.
Consistently outperforms the market
ESG stocks have a strong history of outperforming the market in the past decade, and have done particularly well during the 2020 pandemic. As ethical and environmental practices continue to gain traction thanks to environmental movements and focus in the business world, more investors are interested in buying into ESG stocks. Based on past financial performance and the current emphasis on ethical and environmental practices, ESG stocks are anticipated to continue to perform well.
Allows you to feel good about where you’re putting your money
One of the main advantages to investing in ESG stocks is knowing you’re supporting businesses that are committed to meeting environmental standards, focusing on ethical practices, and continuing to evolve in a socially conscious manner. If you like to feel good about the types of companies you’re buying ownership in, ESG investing is a great option.
Not only do ESG stocks perform well over time — they’re also lower risk options. If you can identify a true ESG company, you’ll most likely be taking on a less risky investment. Since ESG focused companies focus on fair practices and adhering to government regulations, they tend to be less volatile and have stronger reputations.
Excludes some profitable opportunities
Of course, on the downside, if you focus solely on ESG investing, you’re likely to miss out on some short- and long-term investment opportunities. Although supporting ethical and environmentally-conscious businesses can be profitable, there are many other corporations and startups that continue to outperform the market.
If you’re more of a passive investor, you might have considered ETFs or IPOs to diversify your portfolio. While these investments are often safer and more likely to witness steady growth over time, some of the most lucrative options (particularly those that offer portions of stock from the S&P 500) will not always align with ESG criteria.
Requires more research
Determining if a company meets ESG standards can be time-consuming and might require combing through sustainability reports. If you’re working with a financial advisor, you might be charged extra if you decide to focus on ESG dedicated companies. If you’re handling your own investments, be ready to spend significant time looking into the companies you aim to support, and be sure to keep up-to-date on their practices in the future.
In fact, many companies may claim to be ESG friendly, but after research, you might find that their sustainability reports do not reflect these allegations. Since ESG companies are trendy right now, many corporations that do not fully align with this definition are alleging to be “eco-conscious” or “environmentally aware.” Ultimately these claims don’t hold any weight if there’s no data to support them.
This extra research might not be an issue for already active investors, but if you prefer to buy in to good opportunities without timing the market or researching a company in-depth, ESG investing might be more of a challenge than you’re looking for.
How to start investing in ESG stocks
If you’re interested in switching your focus to ESG investing or if you’d like to diversify your portfolio with more environmentally focused and sustainable investments, I’ll show you how to get started.
Decide how you want to invest
Before jumping in, it’s important to decide if you want to invest actively or passively. If you’re interested in doing all of your own research with your own brokerage account, you’ll want to begin by building your own ESG portfolio. To do this, you’ll first need to open a brokerage account (if you don’t have one already).
If you’d prefer to work with a financial advisor, you can hire a stock broker or sign up for a robo advisor platform. Robo advisors are typically more affordable than traditional financial planner services, but can streamline investing, offering you flexibility in how your portfolio is handled. Many robo advisor platforms are now offering ESG options, but be sure to double check before signing up.
Reflect on your ESG values
While the components of ESG are pretty clear, you might have additional values and ESG issues that will help you define the types of companies you want to invest in. For instance, women investors who want to focus on empowering women-funded startups and companies with diverse boards of directors and leadership teams might opt to use a platform like Ellevest that shares these same values. Likewise, if you feel passionately about animal rights, you might only want to invest in companies dedicated to cruelty-free practices.
Define your own core values within the ESG guidelines so you can better focus on the companies that meet your specific ethical investing criteria.
Choose your ESG investments
Now, you’re ready to choose the companies you want to invest in. You might decide to invest in individual stocks or mutual funds, depending on your investment preference. If you’re investing through a traditional investment brokerage platform, you can search for the companies you want to invest in and begin buying. If you’re using a robo advisor or other financial planner assisted tool, you might have options to search for specific stocks or filters to identify ESG designated companies.
Robo advisors offering ESG designated investing options
|Robo Advisor||ESG Only?||Fees||Minimum Investment|
|Betterment||No||0.25% - 0.40%||$0|
|Ellevest||No||$1 - $9 monthly||$0|
|Ally Invest||No||0% - 0.30%||$100|
|Wealthsimple||No||0.40% - 0.50%||$0|
This robo advisor is one of the top platforms in the investing world. It’s also one of the best robo advisor options for anyone looking to invest in ESG-rated companies. Towards the end of 2020, Betterment rolled out a new SRI portfolio option that contains even more ESG-focused options. Best of all, this easy-to-use platform requires no money to get started and allows you to easily switch your portfolio type at any time.
This innovative robo advisor is a platform focused on the needs of women. This platform is specifically designed to take into account women’s lower incomes (on average), career breaks, distinct lifetime earnings curve, and longer life spans when creating portfolios. Ellevest portfolios have a mix of ETF and mutual funds and members can opt into impact investing accounts, which focus on ESG factors and company governance issues. Membership ranges from $1 - $9 per month and there’s no minimum required to open an account.
Ally Invest offers a brokerage platform for anyone looking to actively invest in stocks or ETFs. However, Ally recently rolled out their new Robo Advisor option, that makes investing easy for anyone who does not want to actively pick and choose each individual investment. Ally Invest’s Managed Portfolios offer SRI options, including ESG funds and other investment options that allow you to invest in ETFs that follow ESG guidelines. There’s no fee for the Cash-Enhanced Managed Portfolio (0.3% for all others) and you’ll only need $100 to get started.
More seasoned investors looking to diversify their portfolios or transition to ESG investments might consider EarthFolio. This top-rated robo advisor invests exclusively in stocks and bonds that adhere to strict ESG guidelines. This platform has a 0.5% asset management fee and requires a $25,000 minimum deposit, which is why it’s often a good choice for more experienced investors. On the upside, you’ll always know you’re investing in socially conscious and environmentally responsible companies.
This robo advisor option is one of the top-rated platforms overall, for its accessibility and ease of use. What I love most about using Wealthsimple for ESG investing is that this platform allows you more customized filters, so you can invest according to your specific values, while still aligning with ESG principles. This platform reviews investment funds for criteria like low carbon emissions, cleantech, social responsibility commitments, gender diversity, and community efforts. While Wealthsmart has a $0 account minimum, this platform charges steep fees ranging from 0.40% to 0.50%.
The bottom line
ESG investing has demonstrated long-term performance in the market and can often be a less risky investment strategy for passive investors. If you’re dedicated to supporting environmental, socially, and ethically-managed companies, ESG investments can make a great addition to your portfolio. You don’t have to choose to only support socially responsible investment opportunities though — you can opt for ESG integration to diversify your existing portfolio by adding in socially responsible options.
Using a robo advisor is the easiest way to begin investing in ESG-compliant businesses, though you can also research and invest in specific companies.