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Impact Investing: What It Is and How to Start

This article provides information and education for investors. NerdWallet does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks or securities.

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.

What is impact investing?

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.

Impact investors see an opportunity in having a proverbial seat at the table. By investing with the goal of having your voice heard, your money can have a broader impact, says Tim Smith, director of ESG shareowner engagement at Boston Trust Walden, a portfolio management firm for socially responsible investors.

“When you’re investing for a double bottom line, the goal is to have profits for yourself but also to have an impact on the planet and our society,” Smith says.

Impact investing versus socially responsible investing

Socially responsible investing” and “impact investing” are often used synonymously, alongside other terms like “ethical investing” and “sustainable investing.” Investors who follow these practices often use 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: Some investors opt to simply exclude investments in what they consider “unethical” companies, some solely include “ethical” investments and others both include and exclude particular investments. That’s why it’s important to understand the methodology behind how investments are chosen for a portfolio.

Can I make money with impact investing?

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 them. In addition, a 2020 research analysis from asset-management firm Arabesque Partners found that 80% of the reviewed studies demonstrated that sustainability practices can 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.)

How to build an impact portfolio

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.

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.

  • Mutual 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 a 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.

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.

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