Impact Investing: What It Is, How to Start, What to Know

Impact investing is a way to do more with your investment dollars.
Alana BensonAug 20, 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.

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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Types of impact investments

Here's a rundown of some important labels.

Socially responsible investing (SRI)

Socially responsible investing” and “impact investing” are often used synonymously, alongside other terms like “ethical investing” and “sustainable investing.”

Environmental, social and governance (ESG)

Impact investors often use environmental, social and governance (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.

Regardless of what you call your form of ethical investing, there are generally three approaches:

  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.

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.)

Does impact investing work?

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).

Domini Investments, a sustainable investment firm, releases quarterly impact reports. According to their 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.

How to build an impact portfolio

If you want to get started with impact investing, there are a few easy steps you’ll need to take.

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 impactful 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 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.

  • 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.

» Research impactful investments. Learn about Morningstar

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.

Frequently asked questions

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.

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.

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.

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

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