What Is Impact Investing & How Can You Become a Socially Responsible Investor?
You’ve probably heard the phrase “vote with your dollar.”
It’s a good reminder that in most societies across the globe, money talks.
That’s why it’s absolutely important to use our voices and our money to encourage the changes we want to see in entities that historically have valued capital above all else.
Fortunately, with impact investing, you can speak in a language they’ll understand.
Impact investors aim to put their money where their mouth is, quite literally. It means taking money and investing it into companies that back causes you care about, whether that’s the environment, affordable housing, social equity, or elsewhere.
It’s a way to be ethical while also being a good steward of your money.
When you think about the finance industry, ethics probably doesn’t immediately come to mind—but things are changing.
As the impact investing market grows, we get more financial channels for making a difference. More and more companies are breaking the mold and, oftentimes bolstered by impact investments, striving to use the money they have for the greater good.
In just the United States, the market of social impact investments is already valued at $4 billion. The Global Impact Investing Network (GIIN) says that across the world, the impact investment market has already topped $1 trillion.
It isn’t just individuals driving this relatively new field of investments. Institutional investors are huge in the private equity impact investing game. These companies invest money on peoples’ behalf and can range from pension funds and hedge funds to banks.
But the question remains: what is impact investing, exactly?
Let’s check those socially responsible stock tickers and talk about how to get into impact investing.
1. What Is Impact Investing?
Impact investing is referred to by a lot of names: ESG investing, socially responsible investing, and, perhaps most descriptively, ethical investing.
So what is ethical investing?
It means investing in socially responsible companies or causes with the goal of:
- Earning a financial return on your impact investment
- Supporting efforts in improving the world in a measurable way, while also NOT supporting unethical “sin” sectors (such as fossil fuels, firearms, tobacco, gambling, private prisons, and more)
That first piece sets it apart from donating. The goal of impact investing isn’t necessarily just to contribute to a good cause. It’s to do that while also seeing your investments grow, or at the very least, to see what you’ve invested come back to you.
In other words, you’re not in this to lose money.
This can feel a little selfish, but remember, money talks. When you grow your financial resources, you grow your ability to drive change. With more money in your pocket from successful investments, you can support what you care about.
That could mean further impact investing, donating to causes that matter to you, or even using that money for good in your own life (e.g., installing solar in your home).
All of this said, the financial returns aren’t the primary priority of impact investing. In fact, they might even be called concessionary investments, meaning you’re willing to concede some profit in order to see social or environmental benefits from the company.
So, when the rubber meets the road, what does an impact investing strategy look like?
That depends. You could start small: research companies, find one that’s publicly traded that you believe in, buy some of their shares, and congrats, you’ve joined the ranks of impact investors.
Or, if you want to scale it up, you can mimic more seasoned investors and diversify beyond just ethical stock investing. This might entail letting a financial advisor or fund managers handle your portfolio.
The key, though, is to make sure that every dollar goes into mission-related investments. You want to make sure you’re contributing to companies that are driving social or environmental benefits.
At its simplest, the impact investing definition: any investment intended to make a positive difference in the world while also delivering financial returns (or, at the very least, not losses).
Categories of Impact Investments
When you invest in a company, you become a shareholder. And that means the company has a responsibility to report certain metrics to you.
With impact investments, you get a way to ensure the metrics that matter to you get met.
Usually, these metrics fall into one of two categories: environmental, social, and governance (ESG, for short) or socially responsible investing (SRI).
Just keep in mind the umbrellas here are fairly broad and the investing industry still hasn’t fully agreed upon definitions for these categories.
What is ESG investing?
First, what does ESG stand for?
With this option, the company gets analyzed through a combination of financial factors and environmental, social, and governance factors. Shareholder expectations — and, as a result, the goals toward which the company is working — blend traditional success (e.g., making money) with things like the company’s environmental impact.
Some skeptics say that companies generally apply ESG practices to avoid issues as much as to make a positive difference. A company applying an ESG mentality might try to minimize its environmental impact not because of earth consciousness, for example, but because they know consumers increasingly expect this.
Still, though, ESG metrics give you a way to measure the company’s impact.
What is socially responsible investing (SRI)?
One socially responsible investing definition states it is “any investment scenario which takes into consideration investment return and social good, in the aim of social change”.
The key here is providing a way to measure and provide proof of that change.
Socially responsible investments generally take things a step further than ESG, laying out specific ethical guidelines that potential investments need to meet.
SRI usually includes metrics that aim to create a measurable, positive change.
For example, if you’re investing in climate change solutions, a true SRI fund should be able to provide measures of things like the exact amount of carbon offset or wattage of green energy generated by your investments.
Climate investing, of course, is one of the easier realms of ethical investing to provide such metrics. Things get more complicated measuring the social and environmental performance for less tangible sectors, like social equality programs.
The murky waters
That said, ESG investments and SRI get used interchangeably.
Across the industry, things are still getting fleshed out. In fact, the term “impact investing” wasn’t even coined until a 2007 Rockefeller Foundation conference, so there’s a lot of growth still yet to come.
If you want to make an impact investment, you should look into what, specifically, makes the company a candidate for an SRI/ESG investment. Because this is still a fairly new field that lacks clear definitions, a company simply saying they tick that box isn’t enough.
Some investments qualify as SRIs because they prioritize an avoidance of harm, for example, but you might want to put your money into companies taking a more proactive approach to driving positive change.
To ensure you’re making truely positive impact investments, do your homework. You either want to be researching the companies individually or choosing a portfolio of impact investments that’s been vetted by a trusted source (we’ll get more into this later).
2. Why Impact Investing Is Important
Now that you better understand impact investing, you’re probably wondering: why is ethical investing important?
You may already buy from brands and sustainable stores you know care about their impact. Isn’t that enough?
Impact investments matter because it gives impact investors (that’s you) a way to create change on a bigger scale than they could individually. You can plant a tree to make a difference.
But by investing in a company that prioritizes reducing greenhouse gas emissions, you may be able to scale your impact in a much more significant way.
The impact investing market gives you a way to support causes you care about. Some examples of impact investing options include::
- Environmental conservation
- Renewable energy
- Financial services for low-income groups (microfinance)
- Affordability of key markets like housing or healthcare
- Sustainable agriculture
- Gender equity
- Ethical production
- Small business
Beyond doing good with your dollar, impact investing gives you—and all shareholders—a way to hold companies accountable. Impact investments are supposed to drive meaningful, measurable change.
That means companies can’t necessarily just say, “We care.” They need to show it.
Say, for example, you invest in a portfolio of companies dedicated to reducing waste in the clothing manufacturing supply chain. They should be able to show you that impact.
How many tons of recycled fabric did they use? How many fewer yards of scrap did their new manufacturing techniques yield per product? How much material did they keep out of the landfill through proper recycling practices?
In short, through the impact investing market, you get two benefits.
First, you get a way to put your money to work to make the changes you want to see in the world.
Second, by becoming a shareholder in companies that say they care about their environmental impact or social responsibility, you get a way to essentially force them to measure their impact. If they’re not measuring up, you can hold them accountable.
3. How Do You Know You’re Investing Ethically?
Impact investing could be just another area of lip service. It could make you feel better about putting your money into specific investments but not necessarily create change.
As you’d probably expect, there’s a lot of greenwashing in this space.
Take Betterment as an example. They specifically offer SRI options vetted according to MSCI’s ESG key issues.
On the surface, that looks good, but if you read the fine print, you’ll find that choosing from their SRI portfolio does “not fully eliminate exposure to companies that investors interested in socially responsible investing may consider to be undesirable“.
On top of that, while they have some SRI portfolios, they also offer one specifically designed by BlackRock. As one of the institutional investors that many blame for the current high barriers to entry into the US housing market, the term “BlackRock impact investing” is nothing more than an oxymoron.
Other Betterment portfolios invest money into ESGU and several other ETFs (exchange traded funds) with direct ties to the fossil fuel industry.
This isn’t to say Betterment is all bad. It’s just a reminder that when you invest—even if you’re trying to make impact investments—it’s not always obvious where your money is going.
How do you know your impact investments are legit?
To ensure your impact investing actually makes a positive difference, you’ll need to do some research or hire someone you trust. You might engage a financial advisor who’s knowledgeable about impact investing to help you identify the right impact investment opportunities for you.
If you’re doing the homework on your own, you may want to start by identifying a few companies that align with your priorities. You could even see if they already have impact investors backing them. As the impact investing market grows, more and more companies are increasing transparency. Look into the details they share about their environmental, social, and governance priorities.
Transparency is a core tenet of impact investing.
If directly investing in ethical companies, they should share exactly which causes they support and provide proof of the related social or environmental impact.
If trusting your money to more diversified ethical portfolios through ethical investing companies, they should make it easy to see which exact causes your money will and will not support.
They should also share what exact ETFs will be used to enact that—so you don’t fall into a Betterment situation and find your money being funneled into an ETF of which ExxonMobil holds the 12th largest share (cough, cough ESGU).
Don’t stop there, though. Again, greenwashing is rampant. Plenty of companies are trying to make themselves look responsible even as they prioritize financial returns over all else (take Coca-Cola as an example).
Ideally, you want their social and environmental solutions and approaches to be vetted by an unbiased third party. Read news articles and find out if any nonprofit organizations have analyzed what they’re doing.
At the same time, make sure they’re generating financial returns, too, unless you plan to see your investment as a donation you won’t recoup.
4. How To Start Impact Investing
Now that you know the what and why of ESG socially responsible investing, let’s get to how to become an impact investor.
Getting started in impact investing means choosing your passion areas. Some people call this a thematic investment.
Essentially, it means deciding what’s important to you and what kind of change you want to put your dollar behind. Your impact investment could center around affordable housing, environmental sustainability, workers’ rights — whatever matters most to you.
Fortunately, you don’t have to navigate these waters alone. There are plenty of ethical investing apps and platforms that can help you explore your options.
While you’ll likely need to do some independent digging to understand individual companies’ environmental impact alongside their social and governance choices, apps/platforms can help to illuminate that along with a stock or portfolio’s financial performance.
That can help you know that your impact investing funds are going to a company that’s positioned to effect positive change long-term.
Individual Shares vs. Impact Investing Portfolios
Getting started also means choosing if you want to buy shares from specific companies or if you want to choose impact investing portfolios, which are essentially a collection of ethical investments.
Choosing a portfolio means your investments are more diversified.
If you put $100 into one company and it flops, for example, you’re going to lose that money. But if you put $10 in 10 companies and one goes bankrupt, you’re only out $10.
Opting for a portfolio over investing in any single company can make it more likely that what you invest will live up to your financial expectations.
That said, choosing a portfolio also means you have several different companies (i.e., all of the ones in the portfolio) to evaluate.
Look into each company or have your financial advisor do it for you. A surprising number of SRI options tuck less-than-ideal investments into their portfolio to bolster the returns for their impact investors.
Are you feeling ready to get started with impact investing? If so, we’ve got some suggestions.
5. Where To Start Socially Responsible Investing
If you want to start investing in ethical funds, we recommend starting with some trusted resources into ethical investing funds.
If finance may as well be Greek to you, you can streamline the research you need to do by opting to trust your money to experts via socially responsible investment firms or apps that either only offer impact investing funds or have pre-built portfolios specifically for impact investing.
Here are some of our recommendations for top impact investing firms:
Once you find an option that appeals to you and offers portfolios that align with your values, sign up and start investing.
You don’t necessarily have to put a ton of money toward it, as some have minimum investment requirements as low as $5.
Ideally, your impact investments will grow. Good financial performance will give you more capital so you can increase your investment and the difference your dollar makes.
6. Social Impact Investing Terms to Know
As you’re exploring the growing world of impact investing, it’s helpful to know the jargon.
Here’s a quick glossary to give you a few need-to-know terms in the impact investing industry.
- Divestment: Selling off interests, including investments. If you already have a stock portfolio and want to start impact investing, for example, you might divest the shares associated with less-than-ethical companies and use that money to buy shares in companies that prioritize positive environmental impact alongside social change.
- ETF: Exchange-traded fund. You can buy these on an exchange just like a regular stock, but they’re pooled securities that track with a particular metric, like an index. For example, the SPDR S&P 500 (SPY) is an ETF that tracks the S&P 500 index. In impact investing, ETFs can get murky. Make sure you understand all the securities that the fund contains.
- ESG: Environmental, social, and governance. In impact investing, you look at how the company performs in these three categories to see if they’re helping to better the world—or at least not making it worse.
- Portfolio: A collection of investments.
- SRI: Socially responsible investment/investing. By some definitions, SRI requires more stringent guidelines than ESG.
- Tax-loss harvesting: Selling investments on the low end but rather than cashing out, using that money to buy other investments. This limits taxation. And if you’re trying to get into impact investing, it can give you a way to move your money into more ethical companies while minimizing what you pay in taxes to do so.
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Final Thoughts On Impact Investing
Ultimately, impact investing gives us a way to do good with our money and take our values all the way to the socially responsible bank.
Whether you’re trying to figure out where to put pension funds or you’ve got some excess cash on hand, choosing impact investing means you’ll be able to put your money where your mouth is.
It doesn’t matter how much money it is, either. Climate investing and other ethical portfolios are not reserved for those with a $100,000 portfolio. Just as little, everyday changes go a long way toward more sustainable living, small investments matter greatly when taken into account as a collective.
If you know a prospective impact investor looking into how to invest in ESG—whether new to the money market or seasoned investors looking to move their money into something better—give this article a share to help put ethical investing into a bull market.