What Is Impact Investing?

Impact investing is a way to do more with your investment dollars.
Alana BensonOct 6, 2021

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Making a difference goes beyond volunteering and donating money: It can also extend to your investments. Impact investing is a way to put your investment dollars to work, promoting good in the world and in your portfolio.

Impact investing definition

Impact investing is the practice of investing in companies that create measurable social or environmental change in the world — and generate a financial return. To start impact investing, you can invest in companies that promote sustainable business practices or have animal cruelty-free initiatives.

» Ready to get started? Jump to how to build an impact investing portfolio.

Since everyone has different values, where you want to have an impact may differ from someone else. Some investors may use their religion to guide their investment choices, others may feel moved to act by current events. But no matter what your values are, you can find impact investments that align with them.

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Impact investing vs. socially responsible investing

The world of impact investing is full of labels, but some mean more than others. Here is what each one actually means and how they are used to create impact portfolios.

General terms

Labels such as socially responsible investing and impact investing are often used synonymously, alongside other terms like ethical investing and sustainable investing. They usually refer to a similar idea: Using your investing dollars to make a positive difference in the world.

Environmental, social and governance investing

Impact investors often use environmental, social and governance, or ESG factors, which are a set of guiding principles that focus on environmental, social and corporate governance concerns, when choosing investments.

Many independent research firms use ESG scores to help grade investments along an ethical curve. For example, if you’re creating an impact portfolio focused on the environment, you may look for investments that receive a high ESG score in the environmental category.

Impact investing strategy

Regardless of what you call your form of ethical investing, there are generally three strategies for making your portfolio more impactful:

  1. Exclude investments in what they consider "unethical" companies.

  2. Include “ethical” investments.

  3. Include and exclude particular investments.

That’s why it’s important to understand the methodology behind how investments are chosen for a portfolio.

How does impact investing work?

On a large scale, impact investing works by channeling investor dollars into companies that promote good in the world, or avoiding those that do not. For example, an investor may choose to put their investment dollars toward a renewable energy company over an oil company.

Impact investment fund reports provide information about the real-world changes the fund is making through its investment choices. However, specific investments aren’t the only ways of making an impact; activism can also have an effect.

For example, according to the latest data from BlackRock, the company's iShares MSCI USA ESG Select ETF (one of the highest-rated ESG funds) has 44.06% lower carbon emissions than its reference benchmark (the MSCI USA index).

Is impact investing profitable?

In short, yes. According to the Global Impact Investing Network’s 2020 Annual Impact Investor Survey, 68% of respondents reported that in 2019 their investments met their financial expectations; 20% said they outperformed. In addition, a 2020 analysis from asset-management firm Arabesque Partners found that 80% of reviewed studies demonstrated sustainability practices positively influence investment performance.

As with all forms of investing, impact investing does pose some risk. However, sustainable funds may offer lower risk than traditional funds. Having lower-risk investments can help protect your investment portfolio from market turmoil. In fact, according to Morningstar data, 24 out of 26 ESG index funds outperformed comparable traditional funds during the first quarter of 2020, when the COVID-19 pandemic was ramping up around the world. (Morningstar is a NerdWallet advertising partner.)

Impact investing examples

Impact investments can come from individuals, private companies, foundations, religious institutions, pension funds and fund managers. Shareholders of all kinds can help reshape company policies by voting with their values. Here are a few impact investing examples:

Impact investments made by individuals:

  • Some robo-advisors offer automated socially responsible portfolios, which help clients make impact investments without having to do the research themselves. For example, Betterment’s 100% stock Climate Impact portfolio has half the carbon emissions per dollar of revenue than Betterment’s  100% stock Core portfolio.

  • Individuals who are looking to invest on their own can invest in ESG funds, which have more strict requirements than traditional funds, but still provide financial returns. For instance, the Xtrackers S&P 500 ESG ETF outperformed the S&P 500 Index during the volatile years of 2019 and 2021 — all while excluding companies involved in the tobacco, controversial weapons and thermal coal sectors.

Impact investments made by companies and foundations:

  • The Rockefeller Foundation provides grants, but it also invests. The foundation invested in the Disability Opportunity Fund, which helps finance projects that provide housing, schools, and job training for people with disabilities. Because of the Rockefeller Foundation’s investment, the fund can increase the number of loans it gives.

  • Bank of America, Capital One Wells Fargo Bank and other institutions invest in Craft3, a nonprofit lender that loans money to other nonprofits and startup businesses. Craft3 lent money to Carla Cabiya to start Kre-8-tive Kidz, a bilingual childcare center. The center could not secure traditional financing, but Craft3 provided financing and Kre-8-tive Kids went on to create four full-time jobs and provide assistance to low-income families.

Impact made by shareholder advocacy:

  • Morningstar reported that the average support for environmental and social shareholder resolutions hit a record 34% from July 2020 to June 2021. Support for the 26 climate-related resolutions rose to 51%.

  • Domini Investments, a sustainable investment firm, releases quarterly impact reports. According to its Q3 2020 report, Domini Investments sent letters to 161 CEOs and board chairs calling for firms to develop net-zero business strategies and announced that the fund will not invest in any company without representation of women on either its executive management team or board of directors.

While lots of companies claim to be making an impact, their claims can sometimes be exaggerated or simply untrue. This is called greenwashing, and it threatens the legitimacy of well-meaning companies and investments.

How to build an impact investing portfolio

If you want to get started with impact investing, there are a few easy ways to do it.

1. Determine your impact area

What are the issues you care about? If you’re passionate about sustainable energy, you’ll want to ensure you invest in assets that cater to that. Deciding where you want to create an impact can help you narrow down your investment choices later.

2. Decide if you want a DIY portfolio or to get help

You can pick your investments yourself, but understand that it requires a lot of research. Some robo-advisors (digital services that choose and manage investments for you) offer socially responsible portfolios — no research required. A handful even offers specialized impact portfolios, so you can ensure you have an impact in the areas you care about most.

» Invest ethically (and easily). Explore robo-advisors with socially responsible portfolios

If you want to create your own impact portfolio, you’ll need to have a brokerage account to do so (here’s how to open a brokerage account). This is where all your investments will live, and where you can buy and sell specific assets. If you opt to work with a robo-advisor, you can stop here.

3. Find impact investments

If you want complete control over your investments, you can pick mutual funds that have strong ESG scores or buy stock in individual companies that have a mission you want to support. Here is a rundown of those two types of investments.

  • Impact investing ETFs and other funds allow you to invest in many different companies all at once, and the field of ESG funds is growing quickly. Look through a fund’s prospectus to find the small print about what you’re investing in. You’ll want to look for two things in particular: a list of all the companies an impact investing fund invests in (also called its holdings) and the fund’s expense ratio. Expense ratios are annual fees taken as a percentage of an investment. For example, if you invest $10,000 in a mutual fund with a 1% annual expense ratio, you’ll pay $100 a year. Impact investing ETFs tend to have lower expense ratios than mutual funds.

  • Individual stocks. Individual stocks represent a slice of ownership in one particular company. While many financial advisors suggest limiting the number of individual stocks you own in favor of mutual funds, you nevertheless may want to buy stock in companies you believe will increase in value (and those that have a mission you want to support). To figure out if a company is having the kind of impact you care about, look for its sustainability report, which will give you a sense of any impact initiatives the company has participated in. To see how a company’s employees rate the work culture, check out an independent site such as Glassdoor.

4. Increase your impact

In order to make sure your investments are having the impact you want, there are two important things you can do. The first is to use your shareholder voting rights. If you decide to purchase individual stocks, you likely have the right to help that company decide its policies. As a shareholder, you can use your voice through your “proxy,” which is the ballot that shows what resolutions or policies are up for a vote.

To vote your shares, start by reading the proxy materials and filling out your ballot before the company’s annual general meeting. If you don’t receive a ballot, you can contact the company yourself or through your financial advisor.

The second thing to do is request an impact report if you didn’t already while researching your investments. These reports hold companies and fund managers accountable and give you an opportunity to see how your investment dollars are creating change.

How big is the impact investing market?

The Global Impact Investing Network’s 2020 Annual Impact Investor Survey estimates that the current impact investing market is roughly $715 billion. That number is likely growing, since the financial flows into sustainable funds more than doubled from 2019 to 2020 and the number of available funds rose 30% from 2019.

Impact investment companies include fund managers that make impact investments for their clients and companies that invest money in impactful ways.

How are impact investments measured?

An impact investment is often graded using an ESG score. This score measures how well a company or fund stacks up in terms of environmental, social and governance factors. But note that companies currently use various methodologies for calculating ESG scores, so there's no one authority on ESGS scores.

You can understand an investment’s impact on the real world by reading its impact report. This report may outline how much a company has reduced its carbon footprint, or any changes to its policies such as adding extended parental leave.

Disclosure: The author held no positions in the aforementioned securities at the original time of publication.

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