Impact Investing: 5 of the Best Ways to Start was written by Theresa Bedford and originally appeared on Savoteur. It has been republished with permission.
World-wide threats from global warming, the COVID pandemic, and social inequality call for change. However, the conversation extends beyond recycling, clean air, and electric cars. People from all backgrounds work to make the world a better place.
The priority shift has led investors to evaluate their portfolios. The desire to outperform the market while making a positive change is enticing and possible. Impact investing makes a difference.
Experts say that impact investing offers competitive portfolio performance. Sustainable investment funds with assets of more than $260 billion have tripled over the past decade, and the growth continues. Bloomberg predicts that ESG assets alone will exceed $53 trillion by 2025. So while the future is unknown and investing risky, change is coming. Impact investing is a trend worth knowing.
What is Impact Investing?
Impact investing was first coined in 2007. As an investment strategy that focuses on corporate social responsibility, it's considered an extension of philanthropy. However, its desire to promote the welfare of others doesn't negate the return on investment.
Impact companies are not necessarily non-profit organizations. Therefore, a company's financial performance is vital.
Impact investments generate positive, measurable impacts to address the most challenging problems, such as energy, poverty, climate change, sustainable agriculture, waste, healthcare, real estate, etc. An impact investor invests in investment opportunities that make an impact on the world.
Most impact investments center around institutional investors, fund managers, hedge funds, private institutions, and foundations. However, individual investors also buy individual stocks that make social impacts with the help of financial advisors and fiduciary experience with impact investments.
What's The Difference Between ESG Investing, Socially Responsible Investing, and Impact Investing?
Impact investing can be confused with socially responsible and ESG investing. However, they're easy to distinguish by their priorities.
The ESG investor wants to see companies that are addressing all three factors. While the socially responsible investor centers on social factors and the impact, investors pick any one cause.
Impact investors measure social and environmental performance. However, the investor's portfolio builds upon the investor's goals and intentions. Some impact investments may not make an environmental impact, while others do. Some may focus on equitable work environments and diversity, while others do not.
Impact investors evaluate a company's social and environmental performance in addition to its return on investment. The investor's portfolio draws upon the investor's financial goals and long-term intentions to improve the world.
Some impact investments may not make an environmental impact, while others do. Some may focus on equitable work environments and diversity, while others do not. Impact investing comes down to what is the intended outcome of the investment.
Types of Impact Investments
Investors will find impact investments across asset classes and sectors, including healthcare, education, agriculture, technology, energy, microfinance, housing, etc. Here are different types of investments that investors may consider:
- Stocks. Stocks are a type of security representing ownership of a fraction of a company. Stocks are bought and sold on the stock market and private exchanges.
- Exchange-Traded Funds (ETFs). ETFs are cost-effective publicly traded funds. They minimize risk by pooling multiple stocks across sectors and asset classes.
- Mutual funds. These funds are similar to ETFs. However, they use fund managers. As a result, they may have higher fees, but they trade for different prices.
- Venture Investments. Private investors finance companies and small businesses with no investment capital to start through private equity and venture investments. This type of investment is risky.
- Entrepreneurship. Impact entrepreneurs look for business opportunities to start socially responsible companies focused on a better world, accountability, community development, and social problems.
How Are Impact Investments Measures?
ESG (Environmental-Social-Governance) scores are calculated to measure how a company performs. Impact investors may focus on the part of the score as they may be interested in a specific impact the company makes in a particular area.
Standardized scoring measures don't exist, and several methodologies exist to calculate ESG scores.
Some companies hire ESG rating agencies to analyze their performance. These agencies report corporate sustainability measures, compensation details, board structure, annual reports, and environmental criteria.
How To Get Started With Impact Investing
- Evaluate your financial goals, risk profile, and investment strategies. Do you understand how to invest? Are you able to manage your investments, or do you need to work with a financial advisor or broker? Consider investment brokers with ETFs or Robo-Advisors if you have a specific area you want to invest in but need to keep your portfolio diversified across an asset class. If you're investing in individual stocks, do your homework and read independent analyses and sustainability reports for impact companies.
- Determine where you want to make an impact. Where do you want to make an impact, and how does it align with your financial goals. Once you've identified your passions, establish a financial plan to invest in those assets. Responsible investing offers shareholders an opportunity to invest in companies that prioritize making a positive social impact.
- Increase your impact through regular investments. Set up an account with an online brokerage that allows you to make automatic contributions. Focus on dollar-cost averaging to build wealth over time and hold onto your investment plan for at least five years.
- Get your finances in order. Pay off bad debt and prioritize investing. Establish good money habits that include budgeting and avoiding debt. Minimize unnecessary spending. Write your goals down and make a plan to achieve them.
- Learn more about investing and impact investing. The best way to make solid investment decisions is to stay engaged in the markets and financial news. Learn how to invest as a shareholder. Challenge yourself to read one book about investing a month. Read quarterly company reports and checkout podcasts to hear a variety of opinions. Knowledge is power. To understand your investment portfolio and see the best financial return, you want to know about world economies, current events, and trends.
Are Risks Lower With Impact Investments?
Investing is risky. However, investing in solid companies minimizes risk with and without responsible business practices. A sustainable business designed with innovation and focused on the long haul is ideal–it's a bonus when they embrace change for a better future.
Some impact investors expect below-average returns that align with their beliefs. In contrast, others can't afford to lose money and pursue competitive market returns. Therefore, developing a diversified portfolio according to risk tolerance is essential.
Is Impact Investing Making a Difference?
The Global Impact Investing Network (GIIN) reported that more than 1700 organizations have approximately $715 billion in impact assets. Impact investors are taking a position to better society and the planet. Yet, its value is considered subjective. What appears to be meaningful for one person may not be significant to another.
Several institutions provide ESG ratings. However, evaluation criteria vary across organizations and reporting organizations.
Cons to Impact Investing
Impact investing is limited in its scope. For example, a shareholder may focus on a few companies changing the world rather than their bottom line return and profits.
Investors aren't philanthropists or social entrepreneurs. Investors are seeking a return on their investments. They need to keep in mind that impact investing is not the same as donating to charities. Be sure to do your due diligence in supporting companies for the right reasons and keep your financial goals in mind. You can invest in a socially responsible business without losing everything.
The Bottom Line
Capitalism isn't going anywhere, and financial returns matter. However, rising interests in climate change, the COVID pandemic, and social movements for equality and human rights have led consumers to question who they use for business. As a result, firms and corporations face real-time scrutiny from societal demands for corporate responsibility in work environments, community engagement, and care for the planet.
The old adage that the customer is always correct rings true regarding how we treat people and the planet. The best companies will attempt to maximize their impact on both social and environmental causes. Impact investors want to address social and environmental issues while receiving solid financial returns. In addition, they want to see philanthropic organizations invested in social change and charitable activities.
As global concerns for economic uncertainty, food and water security, and natural disasters rise, shareholders will prioritize activism, ethical investing, social well-being, and environmental sustainability. Developing a portfolio with impact investments is an option. The choice is yours. Do your homework, learn how to invest, and make the best decision for you and your family.