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Learn how to invest in alignment with your values.
Many retirees nowadays are concerned about the world they’re leaving for their kids and grandkids, with a particular focus on the potential impact of climate change. And financial institutions are paying attention: The New York Times reports that according to Morningstar, there were 588 sustainable mutual funds and exchange-traded funds (ETFs) in the U.S. in late 2022, up from 203 in 2017.
Is it possible to align your retirement investments with your values?
The short answer is yes, given the growth in sustainable investments. A more involved answer considers both conventional retirement investments as well as acknowledging a broader definition of the term “retirement investment.” This post focuses on sustainable investing with conventional retirement investments.
First things first
As a first step, retirees will want to make retirement planning decisions with the goal of balancing the common-sense formula for retirement security:
I > E, or Income greater than living expenses
Conventional retirement investments are individual stocks, bonds, and cash investments, as well as mutual funds or ETFs in these types of investments that pool your investments with that of many other investors. The rate of return on your retirement investments helps boost the “I,” or income, portion of the common-sense formula for retirement security.
When it comes to defining a sustainable investment, it turns out “the devil’s in the details”—there are many ways that can be done. First, you’ll want to reflect on the environmental and social goals that are important to you, consider solutions that are practical for your situation, and balance these considerations with your financial needs.
An important consideration is how far you’re able or willing to go to implement your goals for investing sustainably. For example, you may have some current investments that might not meet your goals for sustainability, but it might not be practical or cost-effective to divest those investments. In this case, you might look for ways to make progress in the right direction, without a total overhaul of your investments.
On the other hand, some investors might have high sustainability standards for their investments. These individuals might be willing to divest any current investments that don’t meet their standards and also pay any related costs, such as incurring taxes on capital gains that they realize by selling these existing assets. They might also be very selective when making new investments, for example, by making sure there are absolutely no investments in fossil fuel companies in the funds they select.
Mutual funds and exchange-traded funds
Many pre-retirees and retirees who have 401(k) plans and IRAs are accustomed to investing in mutual funds and exchange-traded funds (ETFs) from large mutual fund companies and financial institutions. They might even have invested in so-called “socially responsible investment” funds that have been around for a few decades. These funds typically avoided investments and industries that were identified as harmful, such as tobacco, gambling, firearms, alcohol, and fossil fuels, as well as companies that produce a lot of pollution. Such funds might also seek investments that advance social and environmental goals, such as investing in renewable energy, promoting equal rights, or addressing income inequality.
Socially responsible investing has evolved to use the ESG framework that has emerged over the past several years to formally evaluate investments with respect to environmental, social, and government goals (hence the acronym “ESG”). It turns out that there are many ways for a fund to implement a sustainable investing strategy—not all sustainable or ESG funds are the same.
For example:
- “Exclusionary funds” use a passive investment strategy to keep their costs low, investing in a broad index of funds but excluding identified companies and industries that are considered to be harmful with respect to ESG goals. All other companies in the index are included in the fund, whether they’re positive or neutral with respect to ESG goals. These funds can be similar to low-cost index funds that are common in large 401(k) plans.
- “Inclusionary funds” invest in companies in a broad range of industries and are also considered leaders with respect to ESG goals. Such funds may have higher expense charges than exclusionary funds, since they spend time actively managing investments that meet their criteria.
- “Impact funds” focus on companies that address certain environmental or social goals. For example, a fund might invest exclusively in emerging companies that are developing renewable energy sources. In this case, such a fund might be a more speculative investment compared to broad-based exclusionary or inclusionary funds.
- “Green bonds” are debt instruments issued to organizations that finance projects to improve the environment.
If you want to learn more
Tools that analyze and rate sustainable investments are also proliferating. Here are three publicly available tools to investigate.
The respected financial research firm Morningstar has a robust section in their website that analyzes various individual investments as well as mutual funds and ETFs with respect sustainability goals. Each type of investment receives a rating between one and five “planets,” five planets being the rating that is most favorable to ESG goals.
The nonprofit advocacy firm As You Sow hosts a website that evaluates 3,000 mutual funds and ETFs with respect to environmental and social goals. You can start by assessing your current investments and learning the reasons for the ratings.
The Forum for Sustainable and Responsible Investment (US SIF) hosts an online chart that provides data on sustainable funds that are offered by US SIF member firms.
Interest in sustainable investing has been gaining attention recently and will most likely continue to grow with both investors and investment companies. For example, your 401(k) plan might begin offering sustainable funds in the near future that can help you meet your goals. Or, if you work with an investment advisor, you should reach out and have an informed conversation with your advisor about your goals. Either way, you’ll want to craft an investment strategy that supports both your values and your financial security.
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