Many traditional investment models focus solely on financial returns, but an increasing number of investors are realizing that their money can also be used to create positive social and environmental change.
Impact investing is a strategy that aims to generate both financial returns and positive social or environmental impact. By supporting companies that align with certain values, impact investing allows investors to make a profit while making a difference.
Here’s a comprehensive guide to impact investing, including tips on how to get started.
Understanding Impact Investing
Impact investing involves investing in companies or funds with the goal of creating measurable social or environmental benefits. It also involves avoiding investments in companies that do not align with certain moral or ethical standards.
According to a 2024 Morgan Stanley survey, a majority of global individual investors are interested in investments that provide both financial returns and positive social or environmental impact.
While impact investing is gaining popularity, its effectiveness in driving change by shifting investment dollars away from companies with harmful practices is still debated. A study by Stanford University researchers in 2023 found that divestment has minimal impact on targeted companies’ cost of capital, as socially conscious investors represent a small portion of the overall market.
Unlike traditional philanthropy, impact investors expect a financial return on their investment and align their portfolios with their values, whether based on religious beliefs, current events, or environmental issues.
Types of Impact Investing
Terms like socially responsible investing, ESG, green stocks, and sustainable investing often overlap and share the goal of driving positive change through investments.
Environmental, Social, and Governance (ESG)
ESG investing considers environmental, social, and governance factors when making investment decisions, screening companies based on their performance in these areas and potentially excluding those with poor records.
ESG factors include a company’s impact on the environment, social relationships with employees, customers, and communities, and governance evaluating leadership and management.
Independent research firms use ESG scores to assess the ethical performance of investments, allowing investors to prioritize environmentally focused companies with high ESG ratings.
Socially Responsible Investing (SRI)
SRI focuses on negative screening, excluding companies involved in industries or practices that do not align with certain values, such as tobacco, alcohol, or weapons manufacturing.
Financial institutions now offer investment funds tailored to socially responsible investors, including robo-advisors that provide automated portfolios aligned with social responsibility goals.
Benefits of Impact Investing
Impact investing offers benefits to both investors and society, allowing for financial returns while making a positive difference. It also helps diversify portfolios and manage risks by investing in growing sectors.
For society, impact investing can lead to job creation, innovation, and improved access to essential services, contributing to a more sustainable world.
Financial Performance of Impact Investments
Contrary to common belief, impact investing can generate competitive financial returns while also creating positive social impact. Portfolios incorporating ESG factors often show similar or better returns compared to traditional investments.
An analysis by NYU Stern Center for Sustainable Business and Rockefeller Asset Management found that low-carbon strategies had positive financial outcomes. Popular ESG funds like iShares ESG Aware MSCI USA ETF and iShares MSCI USA ESG Select ETF have also demonstrated competitive returns.
Examples of Impact Investing Strategies
There are various ways to engage in impact investing, from individual investments to large-scale institutional funds.
Common strategies include investing in companies with a strong social or environmental mission, impact funds, community investing, and impact bonds that finance social programs with the expectation of financial returns.
Practicing Impact Investing in 4 Steps
Getting started with impact investing is more accessible than ever. Here are some steps to consider:
1. Define Your Impact Goals
Identify the social or environmental issues that matter most to you to shape your investment choices.
2. Decide How You Want to Invest
Choose between a DIY approach or using robo-advisors for socially responsible portfolios.
For a DIY impact portfolio, research is essential, ensuring alignment with your values and diversification to mitigate risk.
3. Do Your Research
Research individual companies’ impact reports to understand their real-world impact and avoid falling for greenwashing practices.
4. Select Your Impact Investments
Consider mutual funds or ETFs with strong ESG scores for diversification and carefully evaluate the fund’s investment focus and expense ratio.
Conclusion
Impact investing allows you to make a difference in the world while earning a profit. Whether you choose automated portfolios or select individual stocks, staying informed and diversified is key to successful impact investing.