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Understanding ESG vs. Impact Investing
If you want your investments to align with your values, you may be considering an approach that incorporates impact investing or environmental, social, and governance (ESG) investing. While these terms are sometimes used interchangeably, there are significant differences between the two.
ESG vs. Impact Investing
Here’s a helpful way to differentiate between ESG and impact investing:
- Environmental, Social, and Governance (ESG) Investing: Investors and advisors use ESG ratings to evaluate companies based on their operations and past performance. Companies may be excluded from portfolios based on these ratings.
- Impact Investing: Investors focus on companies that they believe will create a positive and measurable social or environmental change.
ESG investing allows investors to refine their choices based on ratings and personal values, aiming to maximize returns while adhering to ESG principles. In contrast, impact investors prioritize creating positive change, with financial returns being a secondary consideration.
How Are ESG and Impact Investing Similar?
Despite their differences, ESG and impact investing share some commonalities:
- Both offer an ethical lens for investing, aligning investments with larger goals or values.
- They cover various types of impact, such as environmental, social, and corporate governance for ESG, and areas like housing, education, and healthcare for impact investing.
- Both involve taking on investment risks.
How Are They Different?
ESG and impact investing also have fundamental differences:
- ESG offers an alternative way to create traditional portfolios, often focusing on publicly traded companies.
- Impact investing tends to focus on private companies and future impact, often requiring accredited investor status.
- Impact investing prioritizes measurable change over profit.
Pros and Cons of ESG and Impact Investing
Both ESG and impact investing have their pros and cons:
| ESG Investing | Impact Investing |
|---|---|
| Can be useful for screening companies and investments | Recognizes that impact can be as important as profit |
| There may be ESG funds within your 401(k) or IRA | Can help create important changes and demonstrate the viability of these types of investments |
| A high ESG score in one area doesn’t necessarily mean the company meets all criteria | Some investments are only available to accredited investors |
| ESG scores don’t necessarily reflect the impact of a company’s products or services | Investing in early-stage companies tends to be riskier |
How to Choose Between ESG and Impact Investing
Rather than choosing one over the other, ESG and impact investing can complement each other. For example, you might invest in ESG funds within your employer-sponsored retirement plans and explore impact investing options within a brokerage account, IRA, or HSA. Consulting a financial advisor specializing in socially responsible investing can also help you identify appropriate investments.
The Bottom Line
ESG and impact investing allow you to earn money while supporting causes you care about. Starting with ESG investing might be easier, but researching impact investing options can also be beneficial. Remember, investing carries risks, but it is often a crucial part of building wealth.
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