The traditional investment approach typically focuses on maximizing financial returns. However, more investors are now realizing that their money can also drive positive change.

Impact investing is a strategy that seeks to achieve both financial gains and meaningful social or environmental impact. This approach allows investors to support companies aligned with their values while still aiming for a profitable return.

Here’s a guide to understanding impact investing and how you can get started.

Impact investing explained

Impact investing centers on purchasing shares of companies or funds with the goal of generating measurable social or environmental benefits. It also involves intentionally avoiding or divesting from companies that don’t meet certain moral or ethical standards.

Interest in impact investing is on the rise. According to a 2024 Morgan Stanley survey, a significant 77 percent of global individual investors are interested in investments that deliver both financial returns and positive social or environmental impact.

However, the effectiveness of impact investing in driving change by shifting investment away from companies with harmful practices remains uncertain. A 2021 Stanford University study found that divestment has minimal impact on a targeted company’s cost of capital — the price they pay for investment. This is partly because socially conscious investors still represent a small fraction of the overall market, about 2 percent.

The Stanford analysis suggested that to significantly impact a company’s cost of capital through divestment, participation from socially conscious investors would need to exceed 80 percent of all investable wealth, an unrealistic level.

Unlike traditional philanthropy, impact investors seek financial returns alongside their contributions. Individual values often guide impact investing, with some aligning their portfolios with religious beliefs, while others respond to environmental or social issues. Whatever your motivation, there are impact investments that can align with your values.

Types of impact investing

Terms like socially responsible investing, impact investing, ESG, green stocks, and sustainable investing often overlap, but they all share a common goal: using investments to drive positive change in the world.

Environmental, social and governance (ESG)

ESG investing takes into account environmental, social, and governance factors when making investment decisions. This approach involves evaluating companies based on their performance in these areas and potentially excluding those with poor track records.

ESG investing focuses on three main factors:

  • Environmental: Assesses a company’s impact on the environment, including energy use, waste management, and resource consumption.
  • Social: Examines a company’s relationships with employees, customers, and communities, considering aspects like labor practices, diversity, and community involvement.
  • Governance: Evaluates a company’s leadership and management, including board composition and shareholder rights.

Independent research firms often use ESG scores to gauge the ethical performance of investments. Investors looking to build an impact portfolio with an environmental focus often prioritize assets with high ESG ratings.

While ESG scores offer insight into a company or fund’s sustainability efforts, it’s important to recognize that different organizations may use varying methodologies, making direct comparisons challenging.

Socially responsible investing (SRI)

Socially responsible investing (SRI) is similar to ESG investing but often emphasizes negative screening. This approach involves excluding companies, sometimes referred to as “sin stocks,” that are involved in certain industries or practices like tobacco, alcohol, or weapons manufacturing.

An increasing number of financial institutions now offer investment funds tailored to socially responsible investors.

Some robo-advisors have also introduced automated portfolios aligned with social responsibility goals, making impact investing more accessible to those without advanced expertise. For example, Wealthfront offers a socially responsible portfolio that increases exposure to companies with high ESG scores.

Benefits of Impact Investing

Impact investing offers several advantages for both investors and society. For investors, it presents an opportunity to achieve financial returns while contributing to positive change. It also provides a way to diversify portfolios and manage risks by investing in emerging sectors.

For society, impact investing can drive job creation, spur innovation, and enhance access to essential services, all of which contribute to a more sustainable and equitable world.

How do impact investments perform financially?

A common misconception is that impact investing requires sacrificing financial returns for the sake of social good. However, research indicates that impact investments can yield competitive financial returns.

Studies, including one by NYU Stern Center for Sustainable Business and Rockefeller Asset Management, have shown that portfolios incorporating ESG factors often achieve returns comparable to, or even better than, traditional investments. The analysis, which reviewed over 1,000 research papers from 2015 to 2020, highlighted that low-carbon strategies also produced favorable financial results.

For instance, two well-known ESG funds illustrate that impact investing can deliver strong returns. The iShares ESG Aware MSCI USA ETF posted an average annual return of 14.7 percent over five years ending in August 2024, while the iShares MSCI USA ESG Select ETF achieved a similar annualized return of 14.6 percent during the same period.

Examples of impact investing strategies

There are various ways to engage in impact investing, ranging from individual investments to large institutional funds. Here are some common strategies:

  • Investing in Mission-Driven Companies: Support businesses with a strong social or environmental focus, such as those in renewable energy, affordable housing, or healthcare for underserved communities.
  • Investing in Impact Funds: These funds aggregate capital from multiple investors to invest in a diversified portfolio of ESG or socially responsible companies.
  • Community Investing: Contribute to local businesses and projects that foster community development and economic growth.
  • Impact Bonds: Invest in financial instruments that fund social programs, with the potential for financial returns if the programs meet their objectives.

How to practice impact investing in 4 steps

Getting started with impact investing is simpler than ever. Here are some steps to guide you:

Define your impact goals

Determine which social or environmental issues resonate most with you. Whether it’s climate change, education, healthcare, or poverty alleviation, your goals will direct your investment choices.

Decide how you want to invest

Decide whether you want to manage your investments yourself or use professional or automated services. Selecting individual investments requires extensive research, whereas robo-advisors provide socially responsible portfolios and often focus on specific impact areas.

For a DIY approach, you’ll need a brokerage account. Here’s a list of top brokers to help you get started.

Do your research

If you’re creating a personalized impact portfolio, thorough research is essential. You’ll need to manually select companies that align with your values and exclude those that don’t meet your criteria.

Managing such a portfolio involves continuous monitoring and ensuring diversification to reduce risk. Most experts suggest holding at least 10 different stocks for a well-balanced portfolio.

Be vigilant about greenwashing, where companies may overstate their social or environmental impact. To assess a company’s true impact, review its impact report, which details achievements like carbon footprint reductions or enhanced employee benefits.

Select your impact investments

For a DIY strategy, consider investing in mutual funds or ETFs with high ESG scores, providing exposure to multiple companies. When evaluating these funds, focus on two main factors: the fund’s holdings (the companies it invests in) and its expense ratio (the annual fee for managing the fund).

While diversification helps mitigate risk, ensure the fund’s investment focus aligns with your impact goals. ESG and similar funds may prioritize different criteria, such as environmental, social, or governance issues.

MSCI offers an ESG rating model, grading companies from AAA to CCC. Additionally, use analysis tools on platforms like Interactive Brokers, which provide comprehensive third-party ratings to aid in your decision-making.

In Conclusion

Ultimately, impact investing combines financial returns with positive global change. Whether you opt for automated portfolios that require minimal management or prefer to carefully select individual stocks, the key is to stay informed about your investments and maintain a diversified portfolio. By doing so, you can both support meaningful causes and achieve your financial goals.