People are more concerned about the environment today than ever before. According to 2023 Gallup research, 95% of people worry about pollution in lakes and rivers, 92% worry about air pollution, and 94% worry about the loss of natural habitats for wildlife.
Given these concerns, it’s unsurprising that many investors seek ways to earn money while supporting their values. Sustainable investing provides options for wealth-building while supporting companies that do good for society.
However, several groups question whether sustainable investing is the answer. Florida Governor Ron DeSantis passed legislation to keep ESG investments, a type of sustainable investment, out of the state, saying, “Corporations across America continue to inject an ideological agenda through our economy rather than through the ballot box. Today’s actions reinforce that ESG considerations will not be tolerated here in Florida.”
Others say the fear of sustainable investments is misplaced because these funds’ sustainability claims are simply a marketing tactic.
A May 2023 Atlantic article written by journalist James Surowecki titled “The Hottest Trend in Investing Is Mostly a Sham” argues, “ESG investors, then, aren’t always, or even usually, getting what they think they’re paying for.”
With so many criticisms of sustainable investing, investors might wonder if supporting the causes they care about through their investments is possible. In this article, learn how to participate in sustainable investing to grow your money, avoid scams, and stay true to your values.
Key Takeaways
- Sustainable investing allows investors to build wealth while supporting companies that promote positive change.
- The financial performance of sustainable investing remains a topic of debate, with conflicting research findings on whether it outperforms traditional strategies.
- Investors should research before investing, avoid expensive ESG funds, and use tried-and-true methods to evaluate a company’s financial health.
What Is Sustainable Investing?
Sustainable investing is an investment strategy that considers both the financial returns and the long-term impact on the environment and society. Investors avoid companies that cause harm or seek out companies that promote positive change. Sustainable investors can invest according to whichever values appeal most to them. For example, many investors focus on renewable energy companies, clean water, healthcare, education, or social impact initiatives.
Important
Though some people use the terms sustainable investing and ESG investing interchangeably, ESG investing is a subset of sustainable investing. ESG investors focus specifically on environmental, social, and governance factors, while sustainable investors may focus on a broader range of values.
Why Some Leaders Think Sustainable Investing Is a Scam
Sustainable investing is one of the most highly debated topics in the finance world today. Here’s why this investment strategy has attracted critics:
Higher Fees for a Similar Product
In 2022, Harvard Business Review argued that extra fees associated with ESG funds are used to improve profits for fund managers, writing, “ESG funds typically charge fees 40 percent higher than traditional funds, making them a timely answer to asset management margin compression.” Despite higher fees, a 2022 Harvard study reported that the average ESG fund has roughly 68% of its holdings investing in the same assets as non-ESG funds.
Limited Impact
Critics argue that sustainable investing may not have a significant impact on addressing broader social and environmental challenges. In 2021, Blackrock’s Global Chief Investment Officer for Sustainable Investing, Tariq Fancy, resigned from his position, citing concerns that the work they were doing had no real-world impact.
Fancy explained, “Green bonds, where companies raise debt for environmentally friendly uses, is one of the largest and fastest-growing categories in sustainable investing, with a market size that has now passed $1 trillion. In practice, it’s not totally clear if they create much positive environmental impact that would not have occurred otherwise.”
Tesla CEO Elon Musk has also been critical of the unclear impact of sustainable investing, calling ESG a scam. In 2021, Tesla released an Impact Report stating, “Current ESG evaluation methodologies are fundamentally flawed. To achieve acutely-needed change, ESG needs to evolve to measure real-world impact . . . Current environmental, social and governance (ESG) reporting does not measure the scope of positive impact on the world.”
No Standardized Metrics
Over the past few decades, dozens of agencies have begun gathering ESG information about other publicly listed companies and assigning those companies an ESG score. These scores are meant to inform investors about the strength of the company’s environmental, social, and corporate governance practices.
Unfortunately, it’s difficult to find an objective score. In fact, most agencies creating ESG scores rarely agree on the scores of each company. A 2019 study found significant variations between the ESG ratings from six different top ESG rating agencies. Because of these variations, sustainable investors might struggle to determine which companies are truly supportive of the values they care about.
Financial Performance Concerns
In 1970, economist Milton Friedman wrote, “There is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits.”
In recent decades, many companies and financial advisors have shifted their focus from solely increasing profits for shareholders to incorporating ESG factors. Some financial experts are now raising concerns that ESG factors may not improve a company’s bottom line, and financial advisors should return to focusing on maximizing returns for shareholders.
In February 2023, Vanguard CEO Mortimer Buckley withdrew his firm from the Net Zero Asset Managers Initiative, an organization committed to investing only in companies that are compliant with the Paris Climate Agreement.
Buckley explained that he does not see enough evidence that sustainable investing is the best option for maximizing profits, stating, “We cannot state that [environmental, social and governance] investing is better performance-wise than broad index-based investing. Our research indicates that ESG investing does not have any advantage over broad-based investing.”
The Benefits of Sustainable Investing
While critics of sustainable investing have raised their concerns, there are many reasons this investment trend has caught on. The opportunity to build wealth while living in alignment with your values is enough for many investors to forgive any flaws of this investment strategy. Here’s why many investors have chosen to become sustainable investors:
Grow Your Money
Warren Buffett once encouraged others to begin investing as soon as possible, saying, “I made my first investment at age eleven. I was wasting my life until then.”
Some experts claim sustainable investing will grow your money faster than other investment strategies. However, Capital.com video journalist Asher Isbrucker, says because sustainable investing is relatively new, it’s too soon to tell.
Isbrucker explains, “ESG funds did generally outperform from 2010 to 2020, but they also tend to be jammed full of tech stocks, a sector that enjoyed a booming decade and a rough last year or so, along with ESG funds, so at least for now, the jury is out on this one.”
However, while there is debate over whether sustainable investing provides greater returns than traditional investing strategies, sustainable investors will earn far more in the long run than individuals who don’t invest. As financial writer Robert G. Allen said, “How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.”
Mitigate Investment Risk
In some cases, investors can decrease their investment risk through sustainable investing. This works by avoiding companies that are vulnerable to changing regulations or legal issues that could impact a company’s bottom line.
For example, regulations surrounding environmental sustainability are prone to frequent changes. Sustainable investors who prioritize environmental investing often avoid companies with high carbon emissions or other harmful environmental effects, fearing that future penalties and costly regulations will hurt the investment.
Example
In August 2022, California legislators passed a law banning the sale of new gas-powered cars by 2035. When the law takes effect, it could cause significant losses for car manufacturers and oil companies.
Some sustainable investors proactively protect themselves against the investment losses caused by this type of legislation by avoiding investments in oil companies and car manufacturers that don’t have an electric vehicle branch.
Sustainable investing can also protect investors from risks associated with poor corporate governance practices. Companies with honest, meticulous, and transparent financial reporting, leadership principles, and corporate structures are less vulnerable to fraud charges, lawsuits, tax penalties, and reputation damage, all of which can hurt investor returns.
Example
In 2000, business intelligence company MicroStrategy’s stock fell 62% in one day after it announced it would be redoing its financial reporting for the previous two years due to poor accounting practices. The company was later charged with fraud for reporting profits when it had experienced losses in those years. Investors who prioritize strong corporate governance in their investment decision-making process can avoid losses that result from situations like MicroStrategy’s unfortunate downfall.
Live in Alignment With Your Values
In 2022, Oakland-based certified financial planner Cathy Curtis told CNBC, “Almost every new client I get wants to invest with their values in mind.”
By investing in companies that exhibit responsible and sustainable practices, investors can support initiatives they believe in. Although the list of values sustainable investors hold is nearly endless, here are a few examples of the types of causes many sustainable investors choose to support:
- Fighting climate change: 2023 research from Pew Research Center shows 67% of U.S. adults believe large businesses and corporations are doing too little to reduce the effects of climate change. Sustainable investors who share this belief might limit their investments to companies committed to combatting climate change.
- High-quality education: In 2022, Gallup research found that only 42% of adults are satisfied with the quality of K-12 education in the U.S. Because of this, an education-oriented sustainable investor might want to use their money to support companies that are improving education. For example, an investor may add Stride Inc (NYSE: LRN), a publicly traded ed-tech company, to their investment portfolio because they believe the company is improving education in the U.S.
- Advancements in medicine: Some investors use their money to support companies that are pushing healthcare forward. For example, ReWalk (RWLK) is a publicly traded company that produces technology to allow paraplegics to walk again. Gilead Sciences (GILD) is a biotech company that has developed treatments for HIV and Hepatitis C. Adding these companies to your portfolio because you believe in their missions is a way to participate in sustainable investing.
How to Avoid Sustainable Investing Scams
While investing with sustainability in mind is an admirable goal, remember that many brokerages and investment funds want to capitalize on the rising interest in sustainable investing. In some cases, the finance industry may try to take advantage of your desire to do the right thing by charging you higher fees and offering you little in return. To avoid getting taken advantage of, keep these three strategies in mind:
1. Do Your Research to Find Investments That Embody Your Values
Because ESG scores can vary significantly, be thorough in your research to determine if a company truly supports your values. Try these strategies before investing:
- Look at ESG scores from several reliable agencies: Don’t rely on one score alone. Look at ESG scores from several agencies and check that each agency is a reputable source of information. Some of the most reputable ESG rating companies include Bloomberg ESG Data Service, MSCI ESG Research, and Sustainalytics Company ESG Reports.
- Understand the scoring methodology of each agency: Dive deeper into each ESG score you look at. Learn about the agency’s criteria to evaluate companies, how frequently the scores are updated, and how it weights each ESG factor.
- Read the company’s own report: According to the G&A Institute, 92% of companies publish their own sustainability reports. These reports will give you a more in-depth understanding of the company’s activities than a simple ESG score.
- Stay informed about any companies in your portfolio: As a sustainable investor, it’s important to follow company updates about the businesses in your investment portfolio. Everything from statements from company leaders to announcements of new products and initiatives can strengthen your understanding of whether this company is promoting the values you support.
2. Avoid ESG Funds With Extensive Fees
One of the biggest challenges when getting involved in sustainable investing is learning how to dodge the extra fees. The best way to do this is to avoid ESG mutual funds and ETFs.
Luckily, you can still invest in companies that align with your values, even while avoiding expensive ESG funds. Here are two strategies for sustainable or environmental investing without ESG funds:
- Actively manage your own portfolio: This strategy requires knowledge, experience, and time. But if you have these things, you can be in complete control of your portfolio, ensuring your money is going directly to the companies you believe in.
- Work with a financial advisor who understands your values and goals: If you have limited time and experience, it’s best to work with a financial advisor who can talk with you about the values important to your investment strategy and help you identify companies that fit those values.
3. Use Tried-and-True Methods for Evaluating Stock Performance
The same methods that allow traditional investors to grow their wealth over time reliably also apply to sustainable investors. If you want to see strong returns while investing with your valuables, stick with the investment advice that applies across all investment sectors.
Here are four strategies for evaluating a stock before adding it to your portfolio:
- Analyze the Income Statement: In Warren Buffett and the Interpretation of Financial Statements: The Search for the Company with a Durable Competitive Advantage, authors Mary Buffett and David Clark share how Warren Buffett, the world’s most renowned investor, analyzed an income statement. He used the income statement to look for companies with durable gross profit margins, consistent operating expenses, low R&D expenses, and an upward trend in net earnings.
- Examine Key Ratios: Compare key ratios like price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, and return on equity (ROE) with industry benchmarks.
- Consider Industry Trends: Evaluate the company’s competitive position within its industry. Assess market trends, potential disruptors, and any factors impacting the company’s long-term growth prospects.
- Perform Comparative Analysis: Compare the stock’s performance against its peers and competitors. Factors like market share, growth rates, and profitability can reveal the stock’s relative strength within the industry.
Getting Started With Sustainable Investing
While some investors think sustainable investing is a passing trend, others find that this investment strategy resonates with them. Choosing the right investment strategy for you will take research, reflection on your values, and an understanding of your financial goals. It’s not a decision to make lightly. As investor and financial researcher Robert D. Arnott once said, “In investing, what is comfortable is rarely profitable.”
If you are ready to jump into the investment world, here are the first steps:
- State Your Financial Goals: Determine what you want to achieve with your investments, whether saving for retirement, buying a home, or funding a dream vacation. Clearly defining your goals will help shape your investment strategy.
- Define Your Values: As a sustainable investor, you have an extra step in getting started. Clearly outline the values you want to support as an investor. Be sure to list whether each value is a high priority or a low priority.
- Assess Your Risk Tolerance: Understand your risk tolerance, or how comfortable you are with potential investment losses. Consider your age, income stability, and willingness to take on risk. This assessment will guide you in deciding whether to be a more aggressive or conservative investor.
- Open a Brokerage Account: Open a brokerage account with a reputable financial institution to facilitate your investments. Regularly contribute to your portfolio to benefit from compounding returns. As a beginner, consider starting with low-risk options like index funds or ETFs.
To learn more about values-based investing, check out this article: “What Is Socially Responsible Investing, and What Is Its Impact?“