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ESG vs. Impact Investing: Understanding the Differences
If you want your investments to align with your values, you may be considering impact investing or environmental, social, and governance (ESG) investing. While these terms are sometimes used interchangeably, they have distinct differences that are important to understand.
What is ESG Investing?
Environmental, social, and governance (ESG) investing involves evaluating companies based on their ESG ratings. Investors and advisors use these ratings to assess how companies are run and their past performance. Companies may be excluded from portfolios based on these evaluations.
What is Impact Investing?
Impact investing focuses on investing in companies that are expected to create positive and measurable social or environmental changes. Unlike ESG investing, the primary goal is not just to earn money but also to achieve a “double bottom line” where both earnings and impact are important measures of success.
Similarities Between ESG and Impact Investing
Both ESG and impact investing offer ethical lenses for investing, allowing investors to align their investments with their 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 approaches involve taking on investment risks.
Differences Between ESG and Impact Investing
ESG investing offers an alternative way to create traditional portfolios, often focusing on publicly traded companies. In contrast, impact investing tends to focus on private companies and future impacts, sometimes requiring accredited investor status. ESG investing aims to maximize profits while adhering to ESG criteria, whereas impact investing prioritizes measurable change over profit.
Pros and Cons of ESG and Impact Investing
| Pros | Cons |
|---|---|
| ESG: Useful for screening companies and investments | ESG: High scores in one area don’t guarantee overall alignment with values |
| ESG: Available within 401(k) or IRA plans | ESG: Scores may not reflect the impact of a company’s products or services |
| Impact: Recognizes the importance of impact alongside profit | Impact: Some investments are only available to accredited investors |
| Impact: Can help create important changes | Impact: 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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