Impact Investing: What You Need To Know To Get Started
Volunteering for a cause is praiseworthy, but learning about impact investing is essential if you want to take it up a notch. Impact investing allows you to make financial gains while helping people in need and advocating for a cause. Keep reading to learn what impact investing is and how to build a portfolio.
What Is Impact Investing?
Impact investing, like ethical investing, is a type of investment that strives to create a positive social and environmental impact. Impact investors are typically motivated by one or more of the following objectives:
- Improving environmental sustainability
- Creating positive social outcomes for underserved populations
- Supporting new business models for developing countries
This form of investment is becoming increasingly popular as our understanding of the world around us shifts from an economically focused one to a human-centric perspective.
Impact investing recognizes that everyone benefits when investments are made to improve living conditions for vulnerable and at-risk populations while also generating financial returns.
Impact investing can include:
- Socially responsible or sustainable investing
- Direct investments in for-profit or nonprofit ventures that strive for a social or environmental impact on society
- Impact bonds, which are loans designated for specific projects with high potential payoffs
- Hybrid instruments, such as philanthropic loans used to fund services or infrastructure in developing countries
Is It Profitable?
Impact investing is definitely profitable. A Global Impact Investing Network survey showed that 68% of the impact investors in 2019 met their financial goals. Meanwhile, 20% outperformed their expectations.
The report also found that impact investing has grown in terms of sophistication and depth over time. More importantly, impact investors have a positive outlook for the coming years.
Is It Reliable?
Impact investing is a reliable and rapidly growing financial mechanism to drive social and environmental change, most often generating strong market returns.
Forbes reported that in a GIIN study, impact investors saw a massive increase in aggregate assets, from $502 billion to $715 billion in the course of a year from 2019 to 2020. Amit Bouri, the co-founder and CEO of GIIN, told Forbes, “Impact investing can play a role in reimagining capitalism and reshaping the future.”
Although there’s room for improvement, impact investing has become more reliable over time due to advances in methods that measure impact and enhanced management practices.
In addition, the investment model is bound to become more prevalent in the future. According to Forbes, this model is gaining traction and will potentially serve as an alternative to the “philanthropic way of giving to charities.”
Who Makes Impact Investments?
Impact investments are made by all kinds of investors, especially those driven by an association with a particular cause. These include:
- Insurance companies
- Fund managers
- Nongovernmental organizations
- Religious organizations and institutions
- Private foundations
- Family offices
- Development finance institutions
- Individual investors
Types of Impact Investing
Typically, there are two types of impact investing.
Environmental, Social and Governance Investing
ESG investing is a type of impact investing that integrates environmental, social and governance considerations into investment requirements.
The ultimate goal of impact investing is aligned with that of responsible/sustainable or ESG investing. It also integrates performance metrics that track investments’ potential social and environmental impact against broader market benchmark indices.
This approach informs investors about how their investments perform overall in addition to traditional financial benchmarks. These metrics can include financial return on investment, the social value of investment, benefit-cost ratio and others.
Socially Responsible Investing
This term is often used interchangeably with impact investing and refers to the sustainable and ethical form of investing. For instance, a small-scale apparel brand may focus on using sustainable fabrics rather than promoting fast fashion.
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How To Build a Portfolio
Here are the steps to build a portfolio for impact investment.
Find Your Impact Area
Which issues are you concerned about? For instance, you might be interested in alleviating world hunger or sustainability in the fashion industry. Narrowing down your interests will help you determine the area you want to invest in.
Decide Between Robo-Advisors and a DIY Portfolio
Looking for your own investment options can be difficult and time-consuming. To create your portfolio, you need to have a brokerage account. All your investments will live in your brokerage account, allowing you to purchase or sell assets. Alternatively, you can opt for robo-advisors. Robo-advisors are digital advisors that choose the investments and manage them for you.
Here are the two types of impactful investment options:
- Individual stocks: Buying stocks gives you a certain percentage of ownership in a company. Ideally, it would help if you bought stocks of companies whose mission is aligned with the cause you believe in. If you want to understand the impact of a company in the real world, you can do so by reading its impact report. It will show tangible results, such as the amount of carbon footprint reduction carried out by the company, an increment in the months of parental leave it provides its employees or the number of trees it may have saved.
- Impact investing funds: You can also invest in multiple companies at once. Make sure to look at two things in a sustainable mutual fund: its expense ratio and the companies the fund invests in. The expense ratio is a fee the fund charges for an investment. For instance, if you invest $5,000 in a fund and the annual expense ratio is 1%, you’ll pay $50 a year.
Good To Know
The results of an impact investment are often scored as an ESG score. It measures how well the fund or company performs in governance, social and environmental factors. However, the standards for ESG scores vary among companies and sectors.
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- Global Impact Investing Network. 2020. "Annual Impact Investor Survey 2020."
- Forbes. 2020. "With $715B In AUM, Impact Investors Stay The Course, Despite The Pandemic, Says The GIIN."
- Forbes. 2021. "Environmental, Social And Governance: What Is ESG Investing?"