What is impact investing?

What does impact investing mean?

Impact investing is a strategy of choosing investments that aim to make a positive impact on society or the environment. This may include companies that have specific policies focused on equality within the workplace, or a company that creates products that reduce carbon emissions.

“Impact investing is (in my opinion) where real change happens,” said Michael Reynolds, certified financial planner and principal at Elevation Financial. “Impact investing goes a step further and includes an advocacy component. Funds that follow this path not only divest with an SRI [socially responsible investing] alignment and by applying ESG [environmental, social and governance] screens, but also submit shareholder resolutions and make use of proxy voting and other tools in order to encourage companies to be better global citizens.”

While traditional investing focuses solely on risk and returns, impact investing focuses on how companies are impacting the world and how they approach business — in addition to how these policies can generate strong returns.

There are no specific definitions or laws that define what constitutes impact investing, so many companies or investment funds advertise their impacts through company governance policies, sustainability strategies or environmental impact measurements.

Investment funds that are considered impact investing funds curate a list of companies included in the fund, each with a specific impact it's focused on. This might include clean energy, workplace equality or other social or environmental impact measures.

» MORE: What is a good investment?

Types of impact investing

Impact investing encompasses various approaches, including both SRI and ESG investing. The broader approach to impact investing is investing in companies or funds that aim to improve society or the environment.

Returns on impact investing

While impact investing may limit what companies you choose to invest in, this doesn’t mean you have to sacrifice performance. In fact, a recent study by RBC Global showed that impact investing strategies have mirrored, and even outperformed, traditional investing indexes.

While impact investing approaches can vary widely, one way to measure is to follow industry indexes. For example, the iShares MSCI KLD 400 Social ETF follows the leading 400 companies in the U.S. that promote socially responsible policies and corporate actions. The performance has almost mirrored the S&P 500 over the past 10 years, offering over 11% average annual returns.

Impact investors are also happy with their investments’ performance. The 2020 Impact Investing Study by the Global Impact Investing Network stated that 88% of impact investors reported meeting or exceeding expected returns.

Bottom line: Impact investing does not sacrifice performance.

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How to start impact investing

To get started with impact investing, first research companies that follow ESG standards or SRI approaches. You can manually search through company websites to find more information about the impact they are making, or review ESG ratings through ratings agencies.

For example, Just Capital is a nonprofit ESG research firm that ranks companies annually. You can review the top 100 ESG companies based on their rating, and then perform further research on your own.

Once you’ve found companies or funds you’d like to invest in, you can find them through most major online brokers and investing apps. You can invest in individual company stock, exchange-traded funds (ETFs) or mutual funds, depending on your favored investment approach.

Reynolds recommends seeking out funds that go beyond just ESG ratings. “In my opinion, if you want your money to go toward real change, you need to seek out the impact component,” he said.

“It's fine to make a statement by investing in ESG-themed funds but divesting from fossil fuel companies (for example) can seem more nebulous when it comes to true impact — these companies don't ‘feel’ it as immediately or directly. The true impact funds work toward improving the behavior of these companies with real advocacy work, which truly has a direct impact.”

Impact investing examples

Impact investing doesn’t have set guidelines or benchmarks to follow, and you can invest in both public and private investments, depending on your strategy. Here are a few examples of impact investing:

• Investing in a public company with a high ESG score
• Investing in a fund that only holds highly rated ESG companies
• Making private investments in a small business that has a positive impact in your local community
• Peer-to-peer lending (or “micro loans”) to small business owners in impoverished communities

Remember that it’s important to create a diversified investment portfolio to spread your risk across various investments, even within the impact investing approach. This may mean finding a mutual fund or index fund that owns hundreds of stocks, or simply choosing investments across different asset classes.

As with any investment approach, it’s always a good idea to consult with a licensed financial advisor to help you put together a plan.

Bottom line

Impact investing is a great way to put your money where your passion is, and you can earn a solid return while helping society and the environment at the same time.

As a relatively new concept, there are very few regulations or definitions around what constitutes impact investing, so it’s important to do your own research before choosing any investments. But impact investing doesn’t always sacrifice investment performance, and in some instances, it can outperform industry benchmarks.