Imagine a world with clean air, clean water, and forests for days. Medicine and food for those who need it. Is there anything else you can do to make a difference? Social issues and challenges are part of our lives, and lots of investors are looking for investments that represent their beliefs.
ESG (Environmental, Social, Governance) investing has been around since the 1800s. It was made famous in the 1960s following the civil rights movement and later by the Vietnam war and the development of mutual funds. Today, ethical considerations and values continue to set the foundation for some investors as people call for answers on global warming, pollution, wealth inequalities, human rights, and diversity.
ESG investors incorporate environmental, social, and governance factors into their investment decision-making. They seek to invest in companies that maintain high activism and land conservation standards. Keep reading to learn more about how to get started in ESG investing.
What Is ESG Investing?
ESG investing is an investment strategy that considers environmental, social, and governance factors when building an investment portfolio. The US SIF Foundation reported that ESG assets have grown from $12 trillion in 2018 to more than $17 trillion in 2020.
Investors exploring ESG investments use non-financial factors to measure how a company treats the environment, employees, and operations. These internal and external factors gauge if the company’s ethics and values align with investor expectations.
Here are some areas that ESG investors consider:
Waste and pollution
Green energy initiatives
|Diversity within the organization
Protection of human rights
Fair labor practicesCommunity engagement
|Diversity at the organizational level
Companies don’t prioritize all areas. For example, some organizations minimize carbon emissions, while others focus on green energy initiatives and climate change. Policy changes can address human rights issues, workplace diversity, and equal opportunities. You can use socially responsible index funds to invest in one or more of these causes.
However, other problems may require operational changes. Since ESG metrics aren’t necessary for financial reporting, companies may choose to report on areas that best align with their strategic goals in standalone reports.
What are ESG investments?
You’ll find ESG investments across many sectors and industries. For example, you can invest in stocks, exchange-traded funds (ETFs), mutual funds, real estate, crowdfunding, or through ESG startups.
Real estate investment trusts (REITs), mutual funds, and ETFs minimize risks through diversification. These funds strategically omit companies that don’t meet ESG criteria while maximizing returns.
How Are ESG Ratings Calculated?
Trying to figure out a fund’s ESG rating is where a lot of people get hung up, because most investment prospectuses don’t include them. So to find the ESG rating you can:
- Do research to determine which companies meet your expectations for ESG investing.
- Rely on an ESG financial advisor.
- Utilize an ESG Robo-advisor through an online investment brokerage platform.
The Securities and Exchange Commission (SEC) has set up a website to track ESG investments. However, evaluation criteria may vary across rating firms. For example, some companies hire ESG rating agencies to provide a rating that investors can use. These firms use annual reports, board structure, compensation details, and corporate sustainability measures to calculate scores. In general, higher scores represent better-performing ESG companies.
The financial institutions below all offer ESG ratings:
- MSCI ESG Ratings
- Nasdaq ESG Tool
- S&P Global ESG Scores
- Moody’s ESG Solutions Group
- Sustainability Accountability Standards Board (SASB)
- Bloomberg ESG Disclosure Scores
- The Task Force on Climate-related Financial Disclosures (TCFD)
- The Global Reporting Initiative (GRI)
What’s The Difference Between ESG, Socially Responsible, and Impact Investing?
ESG Investing is often confused with socially responsible investing and impact investing. For this reason, investors need to examine the methodology to construct an ESG portfolio. An ESG portfolio focuses on three specific categories–environmental, social, and governance.
Socially responsible and impact investing may concentrate on one or two types rather than all three as done with ESG investing. For example, a socially responsible portfolio may exclude investments like alcohol or tobacco, while an ESG portfolio would exclude assets like alcohol and tobacco.
The construction of an EGS portfolio can include companies that
- Create a positive impact on the environment.
- Treat customers and employees well.
- Have an acceptable form of governance.
How To Get Started In ESG Investing
There are many ways to get started with ESG investing. Investors can add ESG investments to their current portfolio with stocks, exchange-traded funds (ETFs), mutual funds, or ESG startups. Here are seven steps to start:
Step 1: Create a financial plan. What are your goals? What do you want to do? Outline SMART (Specific, Measurable, Achievable, Relevant, and Time-Bound) financial goals. How much do you want to invest, how often, and why?
Step 2: Open an account. Do you want to manage your investments or hire a financial advisor? Do you meet minimum deposit requirements if applicable?
Keep in mind that actively managed accounts like mutual funds may have higher fees that can take part of your profits over time!
Step 3: Set your ESG priorities. What do you want to see in companies that you invest in? What are the must-have values that companies must uphold? Write down your top priorities and look for investments that meet your expectations. You can use our “spend your values” freebie to figure these things out for yourself.
Step 4: Research your investments. There are thousands of companies with individual stocks and more than 300 ESG funds to choose from in the market. Do your homework by reading about the company, listening to quarterly calls, and reading annual reports. Check out the ESG rating companies above to see their reviews.
Step 5: Set up your budget. Look at your income, expenses, and savings rate. You may choose to invest 10-15%. However, you may select more or less. It depends on your long-term financial goals. Make a goal that is realistic and achievable for you. Then make a plan to pay yourself first every month.
Embed healthy financial habits into your budget to ensure that you minimize debt, maintain an emergency fund, and still have money left to live life. Don’t skip investing. You can consider starting a side hustle if you need more money.
Step 6: Set up automatic payments. The simplest way to ensure you’re investing regularly (and paying yourself first) is to set up automatic payments. Dollar-cost averaging is an investment strategy that schedules investments at regular intervals for a set amount in place of trying to time the market. Investors make small investments every month that are “average” over time. These small investments add up over time.
Step 7: Get started as soon as possible. Whether you’re investing in ESG stocks, ETFs, or mutual funds, the key is to get started ASAP! Compound interest takes time. It’s faster growth over time where you’ll earn money on your investments and the returns at the end of every compounding period. Sometimes it takes years to see its benefits, but once it does–that’s it. Time is your best friend in the market. Check out our ethical investing course to start your ESG investing.
Pros of ESG Investing
ESG investors focus on socially responsible and ethical investments, which they value. For some investors, ESG investing extends beyond their portfolio. They’re taking a stand against companies that don’t share their vision while rewarding companies that do. In the past, ESG investments have performed well.
Cons of ESG Investing
While socially responsible ESG investing is something to be proud of, it’s not the only option. Investors limit their investment options with ESG investments and may pay more to invest in the long run if using mutual funds, financial advisors, fiduciary, or other investment strategies.
Portfolios may suffer if investors focus on non-financial standards to choose investments. Some great investments don’t check all of the boxes for ESG investing. ESG investors may be surprised to learn that some companies claim to be socially responsible but don’t meet the mark. Investors need to remember that the definition of ESG is subjective. Investors will need to do their research before investing.
Investing in ESG investments doesn’t differ from other forms of investing. Investors can invest in stocks, real estate, crowdfunded companies, startups, ETFs, and mutual funds. However, investors exclude investments that don’t align with their values (environmental, social, governance).
There are no hard and fast investing rules for ESG investing. You can have a portfolio with only ESG investments or a mix of ESG and non-ESG asset classes. Creating a more ethical investing portfolio is a journey, and it doesn’t look the same for everyone . ESG investments may come with pride but may cost investors more in the long run in terms of fees, investment returns, and financial performance.
Investing comes with risks. Returns aren’t guaranteed, and past performance doesn’t predict future performance. Investors will need to do their homework to examine the risks and opportunities of ESG investing. That’s why we have our Sustainable Investing 101: Make Money and Be a Good Person course– to help guide you through setting up your ESG portfolio, choosing your investments, and saving the world.
Theresa Bedford is a finance freelance writer. She founded the blog In The Game Investing to encourage everyday people to invest and take control of their money. She enjoys reading, traveling, cooking, and writing. Her work has been featured on AP News, MSN Money, GoBanking Rates, Wealth of Geeks, Savoteur, and more.