ESG Investing: What It Is and How to Start Today

Written by Samantha CatheyUpdated: 1st Sep 2021
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Put your money where your mouth is. That is, as long as you’re verbalizing your values and beliefs when it comes to your investment goals.

Finally, consumers can invest their money in the things that matter most.

What Is ESG?

ESG stands for Environmental, Social and Governance, and it refers to socially conscious criteria applied to companies, mutual funds, index funds, and indices to determine their sustainability.

Maybe you’ve heard it called “sustainable investing” or “socially responsible investing.” Third-party independent rating systems then rank companies based on their resiliency to long-term, financially applicable ESG risks.

What Is ESG Investing?

ESG investing is a strategy where investors financially support businesses that aim to be environmentally friendly and socially equitable, while maintaining ethical corporate governance.

Realizing the three pillars of ESG investing are lofty but worthy goals for companies.

What Are Some Examples of ESG Investing?

Due to the increasing popularity of ESG investing, the list of categories they cover is constantly expanding, and many cross over between categories.

Climate change is likely the first notion you think of when considering environmental impact. This broad concept may include carbon emissions, air pollution, and water security.

Other environmental examples:

  • Energy usage
  • Greenhouse gas emissions
  • Waste management
  • “Green” products and technologies
  • Deforestation
  • Relationship with the EPA or other regulatory agencies

Social criteria measure how a company affects its employees, customers, suppliers, and the community.

In addition to the company’s mission and general higher purpose, investors should look at overall employee treatment including compensation, training, turnover, hiring practices, and safety policies.

Here are a few other examples:

  • Customer service performance
  • Gender and diversity
  • Supply chain sourcing
  • Data protection and privacy
  • Consumer protection
  • Public stance on social justice issues

When thinking about the governance aspect insert “corporate” into your brain for a better picture.

It largely relates to board structure and business ethics, but here are some more specifics:

  • Executive compensation
  • Shareholder rights
  • Diversity of board and management
  • Tax transparency
  • Potential conflicts of interest
  • Lobbying

How to Start ESG Investing (Step-by-Step)

Begin by reflecting about what’s important to you and ask yourself some introspective questions. Start broad and don’t be shy.

What are your beliefs? What do you value? What industries do you want your investment money to support?

Is there anything going on in today’s world you feel strongly about? Labor conditions? Burning of fossil fuels? Gun manufacturing?

Define your objectives and write them down!

#1. Research ESG Funds and Stocks

You’ve gathered your thoughts on what’s important to you as an investor. Next step:research. It’s likely you’ll be attracted to certain aspects of ESG funds and not others, and with so many options it can overwhelming.

As the world changes around us, your values may change, too. Go with the flow.

We encourage investors to conduct their own research, but there are independent research companies that rate the sustainability of other companies in addition to indexes and mutual funds.

Because there is not a universal set of standards, each research firm uses its own methodology which further leads to inconsistencies in ratings.

These rankings do serve as a good introduction to ESG principles, just be sure to review multiple sets of ratings for the full picture. Later we’ll explain how scores are calculated. It’s not how you’d think!

Trusted by countless investors and businesses, Morningstar is also a great resource. “Sustainable Investing” remains the first topic listed when arriving at their website.

If Morningstar’s interface is too complex, as its not exactly tailored to beginning investors, check out As You Sow, the non-profit leader in shareholder advocacy since 1992. While the website does provide a plethora of detailed information, it is easier to navigate.

Don’t want to take time to research individual businesses? Consider sustainable indexes, mutual funds, and ETFs like those by Vanguard, iShares, and Parnassus.

Given the popularity of ESG investing more and more brokerage companies are releasing their version of a sustainability index.

Make sure they present their methodology up-front, and again, don’t forget review several series of ratings.

>> Learn More: How to Research Stocks

#2. Consider All Options and Verify Your Research

Even if you’re confident you’ll be employing the use of an investment advisor (robo or real), you really should conduct basic research to become more familiar with what’s available.

Verify your newly garnered information and consider your advisory options.

#3. Consider an ESG Friendly Robo-Advisor

A blended approach between DIY and a professional advisor, the robo-advisoris a digital guide that will create and manage your portfolio based on your goals and risk tolerance.

An automated investment manager takes out a lot of guess work, but it also will cost to use. Be cognizant of fees and shop around.

Additionally, consider how close (if at all) a robo-advisor watches companies to ensure they do not deviate from their ethical standards.

Popular robo-advising platforms include Betterment, Wealthsimple and Ellevest.

>> More: Best Robo-Advisors

#4. Consider an ESG Financial Advisor

Hiring a financial advisor will cost more than a robo-advisor and certainly more than doing it for free on your own.

But you’ll save time and energy, and you’ll get a full-service approach to your entire financial profile while also exposing pertinent information robo-advisors can miss.

In choosing a professional advisor or financial planner, look at their track-record and inquire into what ESG funds they’ve recommended in the past.

Ask your family, friends and colleagues if their advisors specialize in ESG investments, and cross-reference with the SEC online to verify advisors are licensed.

>> More:Best Financial Advisors

#5. Teach Others About ESG Investing

You’ve opened your brokerage account and filled it with funds you can feel good about. Time to share what you’ve learned!

In the plight for a more just world, the uninhibited flow of information helps everyone make better informed decisions with a positive impact.

What Are the Advantages of ESG Investing?

The misconception investors must sacrifice decent returns with an ESG portfolio has long been put to rest.

In fact, more responsible investments outperformed traditional funds during the Covid-19 pandemic, and research is continually proving ESG funds can reduce portfolio risk even during market downturns.

Additionally, by aiming to address risks that disrupt business (cue PG&E declaring bankruptcy after lighting the state of California on fire in 2019), companies, shareholders and investors benefit alike.

What Are the Disadvantages to ESG Investing?

There are some distinct disadvantages to mull over when considering ESG portfolios.

In particular, expense ratios remain higher than they do in average funds, meaning you may be paying a little extra to invest in ESG funds. This could reduce long-term returns.

Perhaps most detrimental to the sustainable investment movement is the lack of consistent metrics in providing ESG scores.

These scores are calculated by measuring a company’s resilience to long-term ESG risks, not necessarily how good of a steward they are to the world.

As previously mentioned, there is not a solitary set of standards for everyone to follow, which can lead to a false sense of conviction in investors. Furthermore, companies can score low in one or more categories, but average out.

Finally, ESG investing is currently limited in 401(k) accounts but there is hope plan administrators will continue to add more ESG options to employer’s available plans.

Ideally, your retirement goals can someday support activities that don’t contradict your values.

ESG Investing vs. Socially Responsible Investing vs. CSR Investing

While these terms are very often used interchangeably, they are technically different when referring to investment strategies, and it revolves around inclusionary versus exclusionary methodologies.

Socially responsible investing, or SRI, excludes controversial enterprises like gun manufacturing, gambling, adult entertainment and more.

The SRI approach is stricter by not only avoiding certain companies, but by actively seeking those that do have a positive social impact.

For example, an alcohol manufacturer may be included on an ESG list because its environmentally friendly and pushes recycling, or its executive board composition favors diversity.

Using an SRI strategy would exclude all companies producing alcohol regardless of how appealing their boards were. Socially responsible investing is concentrated on individual investor’s values.

Corporate social responsibility, or CSR, isn’t an investment strategy but rather a practice that companies apply to improve their local communities plus the environment and society at large.

Also called corporate citizenship, it’s a business model that helps keep companies accountable.

Look at the methodology of ESG and SRI portfolios to identify which more closely aligns with your priorities. You should have these written down already!

How Are ESG Scores Calculated?

ESG scores are a measure a company’s resilience to long-term, financially relevant ESG risk.

Some of the most esteemed research companies gaging ESG metrics include MSCI, S&P Dow Jones Indices, and FTSE Russell.

The Forum for Sustainable and Responsible Investment uses Bloomberg which provides data on over 10,000 businesses.

Again, these organizations are not providing a numerical value indicative of environmental, social or corporate responsibility. It’s all about risks to their bottom line.

The Bottom Line: ESG Investing

When considering diving into ESG investments, do your research and consider your advising options.

Remember there is no right or wrong way to build your portfolio as long as it centers on what’s important to you.

Saving for retirement is mandatory. Supporting companies, you don’t believe in is optional.

Samantha Cathey
Samantha Cathey

Samantha Cathey is a Senior Personal Finance Writer & Product Analyst with years of financial training and industry knowledge. She is a former banker, loan officer and investment advisor before dedicating her energy to helping individuals more creatively, through her writing. Samantha studied at the University of Idaho where she majored in Journalism and Writing. Her areas of expertise are mortgages, credit cards, loans, and investing.