What Is Sustainable Investing?

Sustainable investing or environmental, social and governance (ESG) investing combines a values-based approach within an investment strategy. ESG investing is a powerful way to build long-term wealth while promoting companies dedicated to environmental or social causes or demonstrating good governance. It’s not only good for the environment but for the bottom line.

Sustainable investing can look different for each investor, with some focusing on one area, such as climate change or social impact, while others choose broad ESG values or the overall sustainability of a company. Read on to start developing your personalized investing strategy with sustainable values. 

How Does Sustainable Investing Work?

Sustainable investing, also known as socially responsible investing (SRI) or ESG investing, aims to generate financial returns while considering the impact of investments on environmental, social and ethical factors. 

Investors can do their own research on companies or use common frameworks like MSCI or Morningstar's Sustainalytics to understand each company’s strengths and weaknesses with reference to ESG indicators. 

Sustainability typically focuses on the positive impact and the potential company vulnerabilities related to ESG, including:

• Environmental risks such as climate change vulnerabilities, water scarcity risks or carbon emissions can open the company to regulatory restrictions or fines. 
• Social risks can include worker safety issues, lack of fair wages or mistreatment of overseas workers. 
• Governance risks can include a lack of transparency in accounting or financial practices, a lack of board diversity or representation or excessive leadership compensation. 

How Does Sustainable Investing Align With Personal Values?

Sustainable investing allows individuals to build a portfolio that reflects their values. With impact or ESG investing, you choose to invest in companies or funds that support ethical and social beliefs to boost causes and initiatives you care about. 

This usually involves exclusionary or inclusive principles. With exclusionary principles, you’ll avoid investing in companies or funds that include (for example) firearms, tobacco, alcohol or fossil fuels. With inclusionary principles, you’ll choose stocks, mutual funds or exchange-traded funds (ETFs) aligning with your values or goals. 

How Can Individuals Start Investing Sustainably?

You can start investing sustainably by choosing an ESG mutual fund or ESG ETF. You can also choose to add individual ESG stocks after researching their ESG standards along with performance and other financial analysis.

To start investing sustainably:

• Researching sustainable investment options
• Decide what percentage of your portfolio you’d like to invest in ESG options
• Understand the specific criteria used by sustainable funds or platforms
• Consult financial advisors who specialize in this type of investing
• Make an initial ESG plan

To research a company’s ESG disclosure, the two leading ESG disclosure frameworks currently are the Global Reporting Initiative (GRI) Standards and the Sustainability Accounting Standards Board (SASB) Standards. 

What Are Some Common Strategies Used in Sustainable Investing?

Different sustainable investing strategies include ESG integration, impact investing and shareholder advocacy. Each approach contributes to sustainable outcomes. Here’s how:

• ESG integration involves including ESG factors in investment analysis to manage risks and improve returns while making an impact.
• Impact investing focuses on a specific sustainable impact, usually related to social issues or the environment, while generating financial returns. 
• Shareholder advocacy involves various activities a company’s shareholders can take to promote ESG goals, from proxy contests to shareholder resolutions. These range from financial and strategic to sustainability-focused objectives.

Is Sustainable Investing Financially Rewarding?

A common misconception is that sustainable investing requires sacrificing profitability for ethical considerations. A growing body of evidence suggests that sustainable investing can deliver competitive financial returns. Compared with traditional funds, sustainable funds have similar performance to traditional funds, according to a Charles Schwab report, and outperformed traditional funds during the pandemic in 2020. 

What Are the Potential Risks Associated With Sustainable Investing?

Be sure to thoroughly research sustainable investments and perform financial due diligence when selecting sustainable investments. Sustainable investments use additional investment criteria, but sustainable investments can still carry market risks similar to conventional investments. To mitigate risk, diversify, invest for the long term, consult financial advisors and perform adequate due diligence

Example of Sustainable Investing

Suppose you want to consider ESG investing, but you're overwhelmed by researching individual stocks or offerings. Instead, you allocate 10% of your total portfolio between ESG mutual funds and ESG ETFs. This is a way to support various companies that support sustainability goals. 

As you research sustainability investments, you can allocate a more significant portion of your portfolio to these funds while allocating a small portion of your portfolio to individual stocks that align with your sustainability goals, such as renewable energy stocks. 

7 Things to Consider With Sustainable Investing

To start investing sustainably, you'll develop a strategy that integrates personal values with the risks and rewards of traditional investing. Here are essential points to consider.

Personal Values

Your personal values will determine the specific ESG factors that best align with your beliefs. Remember that many companies have high ESG scores because they display good governance. While this can be good for investment returns, weighing this factor with the areas or causes you want to support through your investments is important.

Research and Due Diligence

Conduct thorough research on companies, funds or investment options that claim to be sustainable. Look for transparency in their ESG practices, evaluate their track record and verify their certifications or third-party ratings. Be wary of company-produced ESG reports and instead consider objective ESG ratings and sustainable actions. 

Performance and Risk

Sustainable investing does not guarantee superior financial returns. Evaluate the historical performance of sustainable investments and assess the associated risks as you would with any other investment decision.

Diversification

Maintaining a diversified investment portfolio is the most effective way to manage risk. Consider including a mix of sustainable investments across different sectors, regions and asset classes to spread out risk and capture potential opportunities.

Impact Measurement

Investments contribute to positive change. For stronger sustainability impact, look for investments that report on their environmental and social impact with audited reports or third-party verification. This practice allows you to track the progress and outcomes of your sustainable investment choices.

Investment Horizon

With any investment strategy, consider your investment horizon and goals. Sustainable investments may have a longer-term focus, as some environmental or social impacts may take time to materialize. Align your investment strategy accordingly and plan to invest long-term in companies and causes that show strong financial and ESG performance. 

Professional Guidance

If you are unsure about sustainable investing or need assistance, consult a financial advisor specializing in sustainable or socially responsible investing. Read reputed resources on ESG investing, check a company's MSCI or and continue to build an understanding of individual companies' ESG performance. 

Advantages of Sustainable Investing

There are significant advantages of ESG investing, including:

Positive Impact

With sustainable investing, you can help create a better world and promote important causes while building long-term wealth. 

Alignment With Values

By aligning sustainable investing with your personal values, you can ensure that your wealth-building strategy promotes the things you believe in, including social justice, climate change prevention and better company governance. Sustainable investing helps you promote your values and the companies that align with them. 

Long-Term Value Creation

Sustainable investing is a wealth-building strategy that uses additional criteria or filters when assessing a company. Sustainable investing can lead to long-term wealth. 

Market Opportunities

ESG funds have typically outperformed traditional funds, especially in market downturns like the 2008 financial crisis. Whether you're investing in a bull or bear market, ESG investments offer long-term returns with less volatility. 

Competitive Financial Returns

ESG funds perform comparably to traditional funds, offering competitive financial returns, regardless of common misconceptions that suggest the contrary. 

Disadvantages of Sustainable Investing

While this investment strategy offers many advantages, investors' interest in ESG investing has declined since 2020. Here are the disadvantages of sustainable investing.

Limited Investment Options

While ESG investments are rising, reducing your investment portfolio to companies that align with your values means you'll limit investment options. 

Performance Volatility

As major ESG companies have demonstrated in the past year, any investment can suffer from extreme volatility. ESG investments aren't without inherent risks. 

Subjectivity and Lack of Standardization

ESG and sustainability still lack a comprehensive framework. While there has been a push from major stakeholders to create a standardized ESG framework and rating system, it's not yet available. Instead, investors must rely on third-party reporting systems that may be subjective or lack standardization. 

Ethical Trade-Offs

Even with ESG investing, you may have to make ethical trade-offs. If you invest in an ESG ETF, for example, you may invest in companies against your ethical criteria. For example, if environmental impact is important to you, most ESG ETFs include Amazon, which has strong governance but performs poorly in environmental sustainability factors. 

Potential Greenwashing

Sustainability and green products are in fashion, which means companies capitalize on this trend in any way they can, including greenwashing. Greenwashing, or appearing sustainable without appropriate actions to back the marketing or appearances, is rampant across industries. You'll need to do your research to avoid greenwashed investments. 

Limited Track Record

While sustainable investing isn't new, ESG or sustainability reports are new for many companies. That means it's difficult to assess the company's long-term sustainability performance. 

Comparison: Sustainable Investing vs. Traditional Investing

While sustainable and traditional investing can build long-term wealth, fundamental differences exist between the two. The differences are summarized in the following points.

Investment Approach

Individual sustainable investing: Focuses on aligning investments with personal values and supporting companies with strong ESG practices.

Traditional investing: Primarily emphasizes financial returns and company performance and may not consider ESG factors as a core investment consideration.

Values Alignment

Individual sustainable investing: Allows investors to invest in line with their personal values and support causes and initiatives they care about.

Traditional investing: Focuses on maximizing financial returns without necessarily considering the ethical or social impact of investments.

Risk and Return Profile

Individual sustainable investing: Can exhibit a risk-return profile that is influenced by factors such as the performance of sustainable sectors, market sentiment towards sustainability and specific ESG risks, while ideally presenting a diversified portfolio to mitigate risk. 

Traditional investing: Generally focuses on a broader range of investment options, which can lead to a diversified portfolio and potentially mitigate risk.

Long-Term Sustainability

Individual sustainable investing: Emphasizes the long-term sustainability of companies and sectors by considering ESG factors, climate change risks and social impact, along with consistent financial returns over time. 

Traditional investing: Does not explicitly focus on long-term sustainability but instead seeks to generate consistent financial returns over time.

Investor Engagement

Individual sustainable investing: Offers opportunities for individual investors to engage with companies through shareholder advocacy and influence corporate practices regarding sustainability and social responsibility.

Traditional investing: Typically relies on professional fund managers to engage with companies on behalf of investors.

Performance and Returns

Individual sustainable investing: Increasing evidence suggests that sustainable investments can deliver competitive financial returns over the long term, challenging the perception of sacrificing financial performance for ethical considerations.

Traditional investing: Primarily focuses on financial performance, aiming to generate consistent returns according to market conditions and investment strategies.

Creating a Personal ESG Strategy

Building your ESG investing strategy to promote sustainability can be personally fulfilling through positive impact and financial gains. As part of a diverse investment portfolio, sustainable investment criteria can filter companies that align with your values and perform in a changing global market. Is it possible to do good while building long-term wealth? With sustainable investments, the answer is yes. 

Frequently Asked Questions