Consider the Growing Trend of Impact Investing
One of the most exciting aspects of impact investing is that there are so many choices. Whether you’re interested in stocks, bonds, or real estate, investing allows you to weigh your options and build the portfolio that best fits your interests, needs, and level of risk. Of course, the end goal is to secure your financial future.
What if you want to accomplish more than that, though? What if your goal is not just to make money, but also to better society in some way? Recently, an increasing number of clients have asked me about an exciting new trend that accomplishes just that – impact investing – which we’ll explore in detail below. Although you can take a “do-it-yourself” approach using the information shared here, this is an area best navigated with the guidance of a financial advisor with experience in this area.
If the idea of building your portfolio with purpose appeals to you, below you’ll find a few of the decisions you and your financial advisor will explore.
Impact Investing in a Nutshell
Impact investing focuses on the dual goals of generating a financial return and achieving a positive social impact at the same time. Although it differs from simply giving money to a charity, it does have a strong undercurrent of philanthropy. Essentially, the idea is to invest your money in a manner that directly impacts a social, economic or environmental cause, usually in a measurable way. The term ‘impact investing’ was first used in 2007, but this is an investment strategy that has existed among socially conscious investors for decades.
As your financial advisor will explain, there are two ways you can get started:
- Invest in individual companies or projects that show the potential to impact an area of interest for you, such as food insecurity, environmental causes or positive social change.
- Invest in funds whose stated strategies are to focus on impact investing in a particular area that is meaningful for you.
One decision you and your advisor will discuss when undertaking an impact investing strategy is to decide whether to use an “impact first” approach or a “financial first” approach. In the impact first model, the philosophy is to sacrifice returns to some degree in order to achieve a social, economic or environmental goal. Conversely, the financial first model takes positive investment returns into account as the primary goal, with positive impact as a secondary goal.
Both impact first and financial first approaches are valid ways to undertake impact investing, and both will typically make you money. Many impact investors shift from one approach to the other, depending on their annual investment performance, too.
Is Impact Investing the Same as Socially Responsible Investing?
If you read the above and wondered whether this is simply an alternate term for socially responsible investing, it’s with good reason. Impact investing and socially responsible investing share the same underlying philosophy of accomplishing something for the greater good, though they are a bit different in overall approach.
Socially responsible investors are usually using a set of predetermined positive or negative screens to decide which individual companies to invest in. Common positive screens are things like energy efficiency, employment opportunities for the disabled or minority ownership. It can also mean specifically avoiding particular activities or philosophies, where investors use negative screens like tobacco production or a history of pollution to weed out the companies they will not invest in. In essence, socially responsible investors operate with a “do no harm” philosophy.
Impact investors take things one step further by actively seeking to produce a measurable positive outcome. This means they are often more committed to tracking their investments’ impacts through metrics than are socially responsible investors.
Common Areas of Impact
The sectors chosen by impact investors are as varied as the investors themselves. However, the following areas are common targets of impact investing:
- Community Development
- Sustainable Agriculture
- Renewable Energy
Some companies will check more than one box. For instance, a construction company that uses renewable energy and recycled materials might also be focused on providing affordable housing.
It may feel overwhelming to conduct so much research on industries or companies, but remember that your financial advisor or your chosen investment companies will do most of the legwork on your behalf.
By the Numbers: Measuring Returns and Impact
A common assumption is that impact investing isn’t as profitable as traditional, returns-focused investing. However, this isn’t necessarily the case. Returns for impact investors vary wildly across sectors and across individual investors, so it’s difficult to assess an average performance, but the data suggests that around 68 percent of impact investors meet or exceed their financial expectations.
While measuring financial success is largely straightforward, measuring impact proves more complicated. Most impact investors measure the impact of individual companies in two ways: product impact and operational impact. Product impact refers to the positive change that comes directly from a company’s goods or services, such as how many villages are impacted by a water filtration product. Operational impact is a measure of a company’s positive impact on something like its employees or its customers, or even the greater community. For example, a company might provide job training to out-of-work locals as part of its business plan.
Impact investors who are trying to measure the impact of investments funds, rather than individual companies, usually must rely on a fund’s annual reports. They look for things like the number of underserved families who benefitted from free educational resources, or the number of individuals who participated in a workforce development program. Since annual reports include both financial measures and a list of impact initiatives accomplished, investors know both where their money is going and what it is producing.
Measuring your success is another area in which it is useful to rely on a financial professional to lend their expertise and help you sort through the data, annual reports and investment returns.
The impact investing movement is growing each year and, though it takes a bit more effort than a traditional investing approach, it can also be a more meaningful way to use your money and to earn positive returns at the same time. You’ll have to balance risk and reward, as usual, with the added analysis of whether an investment aligns with your social goals.
Whether you’re working with a financial advisor or taking a DIY approach, you can use these five steps to help you get started:
- Decide Your Primary Approach. Is impact most important to you? Or is generating returns your main goal? There’s no right or wrong answer, so choose what makes the most sense for your priorities.
- Set an Impact Goal. Whether the impact is your primary or secondary goal, you’ll need to define it. What constitutes a positive impact for you? Create the impact criteria first, then select an investment that you think can produce a measurable result. For instance, if you want to impact literacy, choose a company whose employees are encouraged to volunteer in literacy programs, then watch community literacy rates to see if they rise.
- Know Your Financial Goal. As with any investment, you need to determine how much you’re comfortable investing, the level of risk you’re comfortable with, and the return you’ll need in order to make the investment financially successful for you. Once you’ve made these decisions, it’s also helpful to consider what you’ll do with your investment proceeds – will you reinvest them for even more impact, or do you hope to pad your retirement savings account? Knowing your financial end game is helpful in shaping the financial component of your impact investing strategy.
- Find Your Investment Opportunities. Once you know your objectives, you can look for funds and companies that align. Your financial advisor will be of great assistance during this step. If you’re going it alone, though, you can always do a simple Google search for something like “eco-friendly companies in California” but it’s also helpful to use the ImpactBase Database through the Global Impact Investing Network. This searchable database is specifically designed to guide impact investors in where to put their money. Creating a profile is free, and you can search based on your desired results-based criteria and on your financial goals.
- Vet Your Options. Once you’ve narrowed your choices, you and your financial advisor should look closely at each company or fund you’re interested in. You can use ImpactBase for this, too, but all public companies must file their financial information with the Securities and Exchange Commission (SEC), and they offer a free database for searching, as well. For information on positive social outcomes, search the internet for press releases or annual reports, or check out the company or fund website.
Make Money, Do Good
Deciding to become an impact investor is a great way to make money while contributing to the greater good. It gives you the peace of mind that comes with understanding exactly where you’re putting your money and what it has the potential to create and providing alignment for your intrinsic values and your financial goals. Does it require a bit more legwork than typical investing? Yes, it does. If this is a meaningful endeavor to you, however, the extra time and energy is well worth it when you achieve both financial gain and a positive impact on the world.
If you’d like to become an impact investor but you’re feeling overwhelmed at the prospect, a financial advisor can be a great resource. Schedule a phone call with us today to learn more about impact investing and to begin building your portfolio with purpose.
For more information on investing and the markets, read our Second Quarter Market Review for 2020.