ESG investing is when an investor uses a set of standards to choose a company to invest in. It can also help investors avoid companies that are at higher risk of lawsuits due to some environmental or social practices, such as poor waste management, toxic emissions or employee harassment.
ESG stands for environmental, social and governance. Here’s what that means:
The environmental side of ESG measures how the company affects the planet through various aspects, including energy use, natural resource conservation, animal welfare, waste and pollution.
The social aspect of ESG covers the company’s relationship with suppliers, customers, employees and the community. This includes employee gender and diversity, customer satisfaction, human rights and fair labor practices.
The governance side of ESG covers how the company is run, including company leadership, executive pay, eternal controls and shareholder rights.
Investing in ESG stocks may not seem like a big deal. But it can have a noticeable impact on your portfolio.
If a company implements the ESG policies, chances are low that it will be hit by a lawsuit from its employees, customers or even the government.
For example, Tyson Foods is a company that saw numerous lawsuits filed against it in 2021 for allegedly misleading shareholders about the company’s ability to combat the spread of coronavirus in its facilities. This dropped the stock price by 8% in the days following the news about the lawsuits. If the company fully implemented the ESG policies, this likely wouldn’t have happened.
You may find claims online that ESG-friendly companies tend to perform better than those that don’t follow ESG policies. This could be true in the long run. However, the performance may also depend on who’s tracking it. Three agencies that track and rank companies based on ESG policies have shown different results, according to one Wall Street Journal article.
For example, Refinitiv showed that companies with poor ESG scores performed better in 2021 than companies with high ESG scores. On the other hand, companies ranked by Sustainalytics showed that those with average ESG scores performed better than those with high and poor scores. Finally, companies ranked by MSCI that had high ESG scores outperformed those with poor scores.
Companies that follow ESG rules in general tend to have strong leadership. This can positively affect company stock performance.
Choosing a company based on its ESG policies may come with some benefits, including:
Despite having some positive sides of ESG investing, there are some things to keep an eye on.
Socially responsible investing (SRI), also known as ethical investing, is an investment strategy that, aside from financial gain, is focused on companies that practice social responsibility and bring social change.
ESG, on the other hand, is a framework by which companies are ranked. The main difference between ESG investing and SRI is that some investors that follow the latter avoid companies that are involved in tobacco, firearms, gambling, fast food, pornograhy and fossil fuel production.
an investing strategy that aims to generate both social change and financial returns for an investor.
Investing in ESG companies and funds is simple. Here’s how to do it:
If you want to invest in companies that share your values for climate change, employee diversity or any other environmental and social value, investing in ESG may be the right option. When you compare stocks, see how the companies rank on each of the ESG values to choose the one you like the most.
There are two ways to invest in ESG companies: finding the companies by yourself or through a robo-advisor. The first option means you have to do the research yourself.
The second is more of a hands-off approach. Betterment and M1 Finance are two popular robo-advisors that allow you to choose socially responsible companies for your portfolio. Once you set your criteria, the algorithm allocates your funds.
Now that you know what to look for, here’s how to invest in the right company:
Investing in exchange-traded funds (ETFs) is another option to get exposure to ESG companies. An ESG ETF is a basket of companies that follow ESG criteria, which can sometimes be a better alternative than investing in individual stocks.
Save money on transaction costs with ETFs because you hold multiple companies with a single transaction. Also, with ETFs, you don’t have to do a lot of research to find the right company —- the fund has already done that for you.
If you’re ready to start investing, the first step is to sign up with a broker. See how these platforms stack up against one another before you choose.
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Finder is not an advisor or brokerage service. Information on this page is for educational purposes only and not a recommendation to invest with any one company, trade specific stocks or fund specific investments. All editorial opinions are our own.
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