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Putting your money where your values are: A guide to socially responsible investing

By Richard Eisenberg

While ESG investing has become easier, it's also not well defined. Here are tips for getting started.

This article is reprinted by permission from NextAvenue.org.

One hot trend in investing today, and one you may want to embrace if you haven't yet, is investing in ways that represent your values.

The practice is often called ESG investing (environmental, social and corporate governance), though some dub it socially responsible investing or, in certain cases, impact investing. Years ago, the name was "ethical investing."

Leading the charge toward socially responsible investing: women. A June 2022 survey by the financial research firm Cerulli Associates found that 52% of women would rather invest in companies that have a positive social or environmental impact; 44% of men felt that way.

"Women want more than just financial return," Janine Firpo, author of "Activate Your Money" said on the "Friends Talk Money" podcast I co-host with Terry Savage and Pam Krueger. "We're realizing that when we invest our money in the things that we care about, it makes our money more meaningful to us."

Krueger, founder of Wealthramp, a firm that vets financial advisers, says advisers tell her that "the clients who are asking these questions [about socially responsible investing] are women." And, she adds, "lots of women who are close to retirement or already retired seem to want to make a difference with their money."

More investments to choose from

Investing this way is becoming much easier to do.

Every major mutual fund and ETF company now sells ESG products. And according to InvestmentNews, U.S. mutual-fund companies last year came out with 70% more of them than in 2020. Similarly, nearly two-thirds of new ETFs last year were ESG-focused.

Roughly two-thirds of financial advisers now use ESG products, InvestmentNews Research has found. A year ago, 59% did.

The Biden administration is expected to reverse the Trump administration's limits on ESG investing in retirement plans this summer, too.

That's apt to make it far more likely that your employer's 401(k) or 403(b) retirement savings plan will offer at least one ESG choice. Currently, according to a 2022 Bank of America study of the 3.1 million participants in the employee benefits programs it runs, only 11% of 401(k) plans offer ESG-focused funds to employees.

ESG is not well-defined

But investing to follow your values requires more than a little caution, especially if you're interested in buying an ESG mutual fund or ETF. That's because financial firms have a lot of leeway in determining what they mean by ESG investments.

For some funds and ETFs, it's about what they don't invest in. For others, it's about only owning stocks in a particular sector, like green energy. And for others, it's about holding stocks with top ESG ratings, though the data underlying ESG ratings, Kenneth Picker and Andrew King recently wrote in the Harvard Business Review, "are incomplete, mostly unaudited, and often dated."

Some critics have names for sales and marketing efforts that play fast and loose with ESG definitions: "doublespeak" and "greenwashing."

Read: Here's how much 'greenwashing' can shave from company earnings

To clamp down on that, the Securities and Exchange Commission has proposed rules restricting the use of the term "ESG" by fund companies and ETFs. SEC Chairman Gary Gensler has said: "What we're trying to address is truth in advertising."

The SEC is also expected to start requiring public companies to provide fuller disclosure about their environmental, social and corporate governance practices.

Keep in mind: your own definition of what might be good or bad for the planet might be much different than the one used by particular ESG fund managers and ratings firms and public companies.

It's also hard to know whether a company's self-declared ESG approach is actually working.

As Stanford finance professor Amit Seru wrote in The Promise and Pitfalls of Investing for Change, an article on the university's Graduate School of Business website, "Good luck measuring the impact of an investment on social or economic inequality. The data are messy, crude, and measured with a lag."

Also see: Subsidies for renewable energy often go to the same fossil-fuel companies that are fighting the green-energy transition with their other hand

Advice for ESG investing

So, before putting a dime into an ESG fund or ETF, read its prospectus and disclosure materials to see how that firm defines ESG. If you plan to buy a particular stock for ESG reasons, read its annual report and website to learn more about whether its values align with yours.

Conversely, remember that just because a company is socially responsible, that doesn't necessarily make it a good investment.

Investing this way also can mean paying steeper fees than what you would pay to own traditional mutual funds and ETFs. In their Harvard Business Review article, Picker and King wrote that ESG funds typically charge fees 40% higher than traditional funds. That's not necessarily a reason to avoid investing in these funds, but it is something to consider when gauging your potential returns.

See: ESG investing was intended to make the world a better place but has become a 'gravy train' for companies, says NYU valuation expert

And that leads to the big question you may be wondering: Will I earn a better return with ESG funds and ETFs than with others? Possibly.

"There's been an enormous amount of research that's been done, and it shows unequivocally that you do not give up financial returns when you invest with your values," Firbo said on my podcast. "In fact, you can meet or even exceed the returns that you see in non-sustainable investing."

The key word there is "can."

A rough 2022 for many ESG funds

Many ESG funds have had a rough 2022. Partly, that's because they often don't own any, or many, oil company stocks; that sector has performed well this year. Partly, it's because sustainable funds are often big owners of tech stocks, a sector that's largely been clobbered lately.

According to Morningstar, a fund and ETF research firm, 65% of sustainable U.S. stock funds are at the bottom of their category rankings this year. But over longer periods, most U.S. stock ESG funds have been in the top half of their categories.

The current trend toward ESG investing, however, could help boost potential returns. "As more investors demand socially responsible companies to be included in their portfolios, you could see a little extra push on those stocks as those stocks become in demand," Savage said.

Check out:These clean-energy ETFs are surging after 'handily' beating the S&P 500 over the past three months

Willing to potentially sacrifice returns?

Regardless, you may be willing to sacrifice potential returns and accept higher fees in exchange for the feeling you'd get by investing with your heart as well as your wallet.

In fact, a 2021 Million Dollar Round Table survey found that 34% of Americans who use financial advisers said they were willing to accept lower investment returns if they could incorporate their personal beliefs into their portfolios.

For help assessing the climate and social impact of ETFs, mutual funds and 401(k) plan investments, the As You Sow nonprofit offers a free online analytic tool There's also Carbon Collective, which has a three-step questionnaire to let you allocate funds to one of its "climate-forward portfolios."

And Savage suggests considering Newdayimpact.com, which runs six portfolios with assorted sustainable goals that let you focus on your impact priority, from clean water to climate action to animal welfare. Newday donates 5% of its net revenues to nonprofits working in the ESG field where you've made your investments, Savage says.

Richard Eisenberg is the former Senior Web Editor of the Money & Security and Work & Purpose channels of Next Avenue and former Managing Editor for the site. He is the author of "How to Avoid a Mid-Life Financial Crisis" and has been a personal finance editor at Money, Yahoo, Good Housekeeping, and CBS MoneyWatch.

This article is reprinted by permission from NextAvenue.org, (c) 2022 Twin Cities Public Television, Inc. All rights reserved.

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08-17-22 0500ET

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