Sustainable Investments: A Beginner’s Guide
You’d like to grow your money, but you shouldn’t have to sacrifice your values in the process.
February 25, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment advisor before making investment decisions.
A common piece of financial advice is to make your money work for you by investing in the stock market. But when it feels like there’s always another news story about the irresponsible business practices of many corporations, you might wonder if there’s a way to use your money to help build the new world rather than prop up the old one.
Fortunately, sustainable investments are more than just a pipe dream — they’re a fast-growing area.
If you want to join the ranks of investors trying to make the world livable and more equitable for future generations, then sustainable investing might be for you. Let’s look at what exactly sustainable investments are, a few ways to get involved and the future outlook.
What are sustainable investments?
Sustainable investing is a catch-all term for making socially responsible investment decisions. There’s no precise definition or set of specific criteria to determine which investments fall under the “sustainable” umbrella and which don’t. Fund managers or individuals might decide on their own criteria, but this depends on the strategy they choose, as we’ll explain shortly.
Sustainable investments are often associated with protecting the environment, but it’s also used as a more general term to describe all types of ethical investing.
Sustainable vs. ESG investing
You might be familiar with environmental, social and governance (ESG) investing, which encompasses three areas:
Environmental: A company’s effort to combat climate change by reducing its emissions, using clean energy or conserving the natural habitat
Social: A company’s treatment of its partners, suppliers, local community and workers
Governance: Management practices such as transparency, avoiding conflicts of interest and allowing stockholders to vote
Many people assume ESG and sustainable investments are the same thing, but ESG investments are just one category of sustainable investments — not every sustainable investment is an ESG investment.
ESG uses a specific framework to analyze risks related to the factors above. When creating ESG investment products, brokerage companies assign ESG ratings to companies; those with a high enough rating are included in the fund.
Above all, the focus is on risks and returns, with the logic that firms exposed to the least ESG risks will be the most successful in the long run.
Sustainable investments don’t necessarily have to view investments through this lens. They may prioritize sustainability over profitability.
Sustainable investing strategies
There’s no limit to the number of ways you can invest sustainably, but there are four main types of sustainable investing strategies:
ESG integration: Considering a mixture of sustainable and traditional factors
Exclusionary investing: Avoiding the least sustainable companies — often those involved in the fossil fuel industry and similar sectors
Inclusionary investing: Actively looking for companies known for highly sustainable practices
Impact investing: Focusing on achieving a positive and measurable social or environmental impact from investments
These investment approaches might sound similar, but they have some differences. An ESG integration strategy is similar to the traditional ESG approach — it forecasts a company’s future financial performance based on ESG factors — but it also gives weight to other aspects of financial performance. Arguably, this is the least “sustainable.”
Exclusionary and inclusionary investing are types of socially responsible investing (SRI) — they’re more proactive with their ethical guidelines than both traditional ESG investing and ESG integration. Regardless of other indicators, a company may be excluded for doing one thing really badly, like having an emissions scandal, or included for doing one thing really well, like avoiding plastic packaging.
Impact investing is similar to inclusionary investing, but it’s also concerned with how much of a measurable impact an investment will have on solving a problem, as well as the financial returns it will achieve.
For example, an impact investor might decide to invest heavily in company A because it avoids plastic packaging, contributes to conservation efforts and is developing cutting-edge operational processes that reduce its carbon footprint. Meanwhile, an inclusionary investor might split their investments equally across company A and companies B, C, D and E, which also avoid plastic packaging but aren’t necessarily making other measurable contributions toward environmental efforts.
Ways to start investing sustainably
The strategies outlined above all offer some guidance about choosing investments, but they don’t explain the actual investment process. Fortunately, if you’re already familiar with traditional investment management, you’ll find that sustainable investments follow a similar approach.
There’s no need for individual investors to handpick sustainable investment products that align with one of the strategies outlined above. These days, many investment companies already have a selection of sustainable financial products.
Generally, the most accessible way to invest is through sustainable funds, which contain a diversified selection of sustainable companies. They can take the form of ETFs or mutual funds. ETFs are passively managed and traded like stocks during market hours. Mutual funds are actively managed.
There are also other routes you could take, such as crowdlending or crowdfunding community projects, but these tend to carry more risks.
You could also invest in individual stocks that you consider sustainable investments, such as Tesla. But this requires more expertise, and again, it’s riskier than investing in a fund with a range of companies.
We can’t emphasize enough that investing comes with risk. The information outlined above is there purely to provide examples of sustainable investments. It’s a good idea to seek help from a financial advisor before investing your money.
The future of sustainable investment
Sustainable investing has grown exponentially in recent years. In 2020, $51.1 billion flowed into sustainable funds in the U.S. compared to just $21.4 billion in 2019 and $5.4 billion in 2018. With the increase in available sustainable funds and people who want to invest aligned with their beliefs, this type of investing is expected to continue its growth.
However, as the world of sustainable investments grows, you’ll want to watch for “greenwashing,” which is when a company claims to be greener than they actually are to attract more investor interest. For example, a company could offer an eco-friendly product line while still maintaining unsustainable manufacturing practices.
Also, bear in mind that emerging markets tend to be filled with volatility, and it can take a while for an established leader to emerge in a sector. Amazon is the leading e-commerce site, and it would take a lot to change that, but in newer markets, like electric scooters, the race is still happening.
It’s important to proceed with caution: A company that seems to be doing well today could be overtaken in a few years.
This is also why you should consider talking to a financial professional before making big decisions rather than following random investment advice you picked up on TikTok or podcasts.
Investing and causes can go hand in hand
Letting your money work for you and seeking profits doesn’t have to be in opposition to the causes you believe in. Through sustainable investments, you can be intentional about where your money goes and the social and environmental practices you support.
You can choose to invest in funds or companies that follow the ESG and sustainable practices that are most important to you. But as with any investment decision, you should be aware of the risks and considerations.
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