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A big trend in investing this last decade has been impact investing! And you may have heard about sustainable investing, ESG Investing, and SRI investing as well. Are those all the same thing?
All these follow the same idea: Investing for a better future. But these investing philosophies are all slightly different. So, we are going to see what they are and how you can invest sustainably.
Even if not everybody wants to invest sustainably, it is still essential to know that this is available. And if you want to start impact investing, this will help you get started.
Let’s start by defining what impact investing is.
The idea of impact investing is to invest in companies that have a positive impact on the world. This positive impact could be for social impact or environmental impact.
On top of that, impact investing does not forget about the returns. It is still investing, so it should generate returns than inflation.
For instance, here are some companies that are favored by impact investing:
- Tesla: By heavily revolutionizing the electric car industry, Tesla has pushed the other car producers to improve their offers as well. They are now leading the electric car movement. Electric cars could have an outstanding impact on the environment (if we fix the battery issue!).
- Beyond Meat: Growing meat in a laboratory saves land, water, and money. Lab-Grown meat could be great for the environment in the future.
- Whole Foods Market: Focusing on healthy food makes Whole Foods Market a very sustainable company.
Now, depending on the investing criteria, some of these companies will not always be selected. For instance, if the goal of the company is to save the earth, but they are using child labor, they will not be included in all impact investing lists. But strangely, they will be included in others.
On the other hand, a company producing guns or operating coal power plants is unlikely to be sustainable.
Types of impact investing
First, there are other names in the same family of investing:
- Impact investing
- Sustainable Investing
- ESG Investing
- SRI Investing
These investing forms are very similar. They have the same primary goal of investing for a better and sustainable future. But they are are not the same thing. It makes sustainable investing very confusing. On top of that, some investment companies add their variants.
So, let’s go over the most used variants of sustainable investing.
ESG stands for Environmental, social, and Governance. ESG Investing is when you invest in companies based on their ESG Factors. An ESG framework will rate companies based on three sets of factors.
First, the companies are going to be rated over environmental factors. For instance, one factor could be the amount of CO2 emissions. Another example could be the impact on biodiversity and population growth.
The second set of factors is social factors. One factor in this set would be the use of child labor. Another often-used factor is the gender-equality and race-equality of the company. Or, we could also be considering how well the company is treating its employees.
The final set of factors is governance factors. Here, we can find about corruption issues in the companies. Another example is how shareholders are treated by companies. They also take into account how the executives are being compensated.
So, these factors are mostly based on the way a company operates. ESG investors are using ESG factors to focus their investments on companies that meet these standards better than others. ESG investors want to focus on shares of companies that are managed with ethical values.
Since these factors focus on the way a company operates, they do not necessarily exclude some companies that are considered harmful. For instance, a company producing weapons in a sustainable way would be fine under ESG factors.
ESG ratings are entirely depending on the rating agency. And there are several of them, and they can rate companies in a very different way.
Socially Responsible Investing (SRI) is another form of sustainable investing where you focus on social factors to choose companies.
SRI investing focuses on excluding companies that have a negative social effect. For instance, SRI criteria will generally exclude tobacco, gambling, and weapon companies.
Factors are also used to include companies in the index, but mostly SRI investing is about not investing in some companies.
There is something important about SRI. SRI investing is tied to the political and social climate of the time. So, if one social factor falls out of favor, your investment could suffer as well.
Impact investing focuses on companies that have a significant impact on the world.
People following impact investing believe that their money will have a positive impact on the world if investing in good companies. For instance, this could invest in companies researching cancer cures.
The positive impact could be environmental and social: green energy and race equality are both valid impacts for impact investing.
Impact investing is very open to interpretation, more than the other variants. Not everybody believes in the same impact. For instance, I think that space exploration has a positive impact on mankind, while other people will tell you it is useless.
Sustainable investing is the umbrella investing around ESG, SRI, and impact investing.
The idea of sustainable investing is just to invest in companies that are sustainable in the long-term. It is very open to interpretation. It is true whether you do it by following ESG criteria, SRI criteria, or by working on the positive impact of companies. In some cases, sustainable investing is based on companies that are sustainable in the long-term. And in other instances, it is focusing on companies that are working for a sustainable environment.
Overall, sustainable investing in all its forms makes sense. The problem is how each of these forms is open to interpretation. You will need a lot of trust in the company that does the actual choosing.
Why invest sustainably?
There are several reasons to invest sustainably.
The first logical reason is that it would be better for the world. Indeed, by investing your money in companies that have a positive impact, you give them an edge over other companies. Indeed, as you are only investing in a kind of company, you are not investing in others. Not investing in companies that are not sustainable has a significant effect as well.
A second reason for impact investing is that the returns could be better. Many people believe that these companies will fare better in the future. As such, they are betting that investing in them will generate more returns.
While I understand the first reason, I am not a fan of the second one. Thinking that you know better than the market what will generate more returns never works. For me, this is market timing. I am not saying that this will not work. I am just saying this is a gamble.
How to do impact investing?
As with everything, there are several ways to do impact investing.
As we will see, this will depend on which variant of sustainable investing you want to focus on.
Invest in sustainable companies
The first way to invest sustainably is simply to invest directly in companies that are sustainable or have a positive impact on the world.
For this, you only need a good broker account. Then, you can directly buy the shares of the companies you want.
There are many problems with this approach:
- You will need to pick all the shares yourselves. It means you will need a lot of work to find which companies are sustainable.
- It will be challenging to balance your portfolio correctly unless you have a substantial net worth.
- You will lack diversification because you will not have many companies in your portfolio.
- It may be expensive in transaction costs.
For me, this is not the way to go. It is simply too complicated. While some people are ready to do the work properly, most people are not. And you will fall in the traps of market timing and stock picking.
Invest in impact ETFs
A better way of investing sustainably is to invest in ETFs directly. There are several kinds of sustainable ETFs:
- ESG ETFs
- SRI ETFs
- Impact ETFs
So, you will have to choose the ETFs you want to invest in. But you do not need 50 ETFs. You probably only need two or three funds if you want a well-diversified portfolio.
Investing in sustainable ETFs is much easier than invest directly in sustainable companies. And unless you have a considerable net worth, this is also cheaper.
And, there is good news, most large ETFs that you know exist in ESG or SRI portfolio. So chances, you can keep your current portfolio and simply take the sustainable variant of these ETFs. So, you can still design your own ETF portfolio and then choose sustainable versions of the ETFs. The TER will probably be slightly more expensive.
The disadvantage of this technique is that you have to trust fully in the provider of the ETFs. Sometimes, the criteria for selection into these ETFs are not entirely clear. But the simplicity of this technique is worth the risk.
For this, the only thing you would need is again, a good broker account. From your broker account, you can directly buy shares of the ETFs.
For me, this is the best way to invest sustainably. I already have a broker account, and I already invest in ETFs. So, I would just need to switch my ETFs to SRI ETFs (or another variant), and I would be done. Investing in SRI ETFs is simple and not too expensive.
Impact Investing with a Robo-Advisor
Finally, the last way to invest sustainably is to use a Robo-Advisor that provides this option.
Using a Robo-advisor is the simplest way of investing sustainably. YOu will pay some extra expenses, but you will not need to pick shares or ETFs, and you will not need a broker account. If you do not want to DIY invest, using a Robo-Advisor is the way to go.
There are some different variants again. Some Robo-advisors only allow you to invest sustainably while others give you the option to do so. Also, some services will invest in single shares, while others will use ETFs instead.
In Switzerland, several Robo-Advisors allow you to invest sustainably:
- Yova with direct investment in shares (impact investing)
- True Wealth with sustainable ETFs
- Selma with SRI ETFs
Yova is the Robo-Advisor with the highest focus on sustainable investing. Find out more about Yova by reading my in-depth review of Yova. If you want more information, I have compared Selma Finance vs Yova for sustainable investing.
As you can see, the world of sustainable investing is more confusing than it should be. In the end, the goal of ESG, SRI, and impact investing is simply to invest in a better future.
People invest in sustainable companies to make their money work for what they believe in. Also, sustainable companies should make it better in the long-term. So it makes sense to invest, especially in these companies.
There are several ways to invest sustainably: invest in companies directly, invest in ETFs, or use a Robo-Advisor. Personally, I would invest in ETFs. But investing with a Robo-Advisor is also a good option.
I am currently not investing in any sustainable instruments. For me, it makes more sense to invest in the entire market. But I understand people willing to not invest in some companies and willing to invest more in some specific companies.
What about you? Are you investing sustainably? And how? Do you follow impact investing?