What Is ESG Investing?

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Donating to charity isn't the only way you can use your money to do good in the world. More and more people are looking to their investment portfolios to make a positive difference.

Socially responsible investing, which allows you to build a portfolio of investments that are in line with causes you care about, has exploded in recent years. U.S.-based assets managed with sustainable investing strategies reached $17.1 trillion at the beginning of 2020—a 42% increase from 2018, according to the Forum for Sustainable and Responsible Investment.

Mindful investing can take many forms, from prioritizing environmental sustainability to devoting more of your portfolio to companies dedicated to diversity and inclusion. The movement has gradually evolved, and today, the primary way folks are investing in the "social responsibility" category is through ESG investing, or investments related to the environment, social issues and corporate governance. Let's take a closer look at how ESG investing works, including different ways to incorporate it into your investment approach.

What Is ESG Investing?

Socially responsible investing is an investment strategy that considers an investor's moral values as well as a company's potential financial returns, and typically excludes investments that don't sync with both. ESG investing is more focused, specifically zeroing in on the environment, social issues and corporate governance. Together, these three factors are considered to determine the potential positive impact of a given investment. The idea is to invest in companies that stand out in one or more of these areas.

Some experts argue that companies that excel in ESG are better positioned for growth because they're actively addressing areas of concern for both consumers and employees. When a company prioritizes things like fair working conditions, diversity and sustainability, for instance, it's demonstrating a commitment to its own workers and the greater community. This, in turn, could make them especially attractive to conscious investors.

Different Types of ESG Investing

Before deciding if a company deserves a spot in their portfolios, conscious investors tend to evaluate the following ESG factors:

  • Environmental sustainability: This is all about the company's environmental footprint. Does it have any renewable energy programs in place? Waste production, energy consumption and the company's overall carbon footprint can all play a role for investors who are concerned about the climate.
  • Social consciousness: How is the company doing in terms of social responsibility? If it has a history of health and safety issues or human rights violations, for example, some may feel hesitant to invest. Conversely, companies that are dedicated to ethical manufacturing and helping to improve local communities may stand out as good investment choices.
  • Corporate governance: Many investors feel pulled toward companies that have robust diversity policies in place and prioritize gender and racial equality. Companies that have a history of sexual harassment or discrimination, on the other hand, may be less appealing.

How to Mix ESG Investments Into Your Portfolio

If you already have a relationship with a financial advisor, opening up a conversation about ESG investing is a great entry point as they can likely guide you in the right direction. Alternatively, you can take a do-it-yourself approach and open an investment account with a brokerage if you don't already have an investment portfolio. Brokerages such as Merrill, Charles Schwab, Fidelity and others provide information and options for investments in this area. Here are a few types of investments to consider:

  • ESG mutual funds: A mutual fund is a basket of investments that is professionally managed. It can include different types of securities, such as stocks and bonds. Instead of choosing an individual stock, the investor owns small shares in a variety of assets, which helps diversify their portfolio. An ESG mutual fund contains securities that meet or exceed generally accepted ESG criteria. Some brokerage firms offer ESG mutual funds linked to a market index like the S&P 500 or Dow Jones Industrial Average.
  • ESG exchange-traded funds (ETFs): Like mutual funds, ETFs are made up of groups of securities and help provide diversification. They resemble stocks in that they're traded throughout the day. Their investments are usually passively managed and tied to a market index. Similar to ESG mutual funds, ESG ETFs are made up of socially responsible companies.
  • Individual stocks: There may be a specific company you're excited about investing in because its values align with yours. If it's a publicly traded company, you can purchase shares of stock. The main objective is to buy stocks when the price is low and then sell them when the price goes up. Investing in individual stocks involves significant risk, so be sure to do your research before plunking down a lot of cash for a single stock.

No matter which route you take, investment research companies like Morningstar lean on ESG data and sustainability reporting to provide company ESG ratings you can evaluate for yourself. This lets you see just how well the companies you're interested in are performing with regard to ESG values as well as financial returns. Of course, just like traditional investing, ESG investing isn't without risk. Investment returns are never guaranteed, and market volatility comes with the territory. Diversifying your investment portfolio can provide some balance and help reduce risk.

Is Now the Right Time to Invest?

Investing can be a great way to build your nest egg over the long term. If you have an employer-sponsored retirement account, such as a 401(k), you're already in the game. Contributing to this type of account sooner rather than later is the best way to take advantage of compound interest and grow your funds over time—especially if your employer offers a match.

Before you open an additional investment account, take a moment to evaluate your financial big picture.

  • Are you paying down high-interest debt? The S&P 500 produced a return of 13.6% annually between 2010 and 2020, according to data from Goldman Sachs. While this isn't necessarily an indication of future market performance (and doesn't account for inflation), it's still worth your attention. If the average interest rate of your debt is higher than that number, it might make more sense to prioritize paying off debt over investing.
  • Do you have an emergency fund? If not, you could end up accumulating credit card debt to see you through your next financial emergency. Before investing, it's best to have an emergency fund in place. Experts recommend socking away three to six months' worth of expenses as a safety net.

The Bottom Line

ESG investing can be a great way to make a positive impact with your investment portfolio. It isn't all that different from traditional investing, except that you're supporting conscious companies while potentially growing your wealth over the long term. Investing is just one part of an overarching financial plan. Building strong credit is equally important. Take the first step by checking your credit score for free with Experian.

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