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.
What does ESG stand for?
ESG stands for environmental, social and governance. Here’s what that means:
E is for environmental
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.
S is for social
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.
G is for governance
The governance side of ESG covers how the company is run, including company leadership, executive pay, eternal controls and shareholder rights.
3 reasons you should care about ESG investing
Investing in ESG stocks may not seem like a big deal. But it can have a noticeable impact on your portfolio.
1. Reduced portfolio risk
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.
2. Potentially higher returns
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.
3. Strong corporate leadership
Companies that follow ESG rules in general tend to have strong leadership. This can positively affect company stock performance.
2 benefits of ESG investing
Choosing a company based on its ESG policies may come with some benefits, including:
Lower risk of lawsuits. Because the company is trying to meet the ESG criteria, chances are it will avoid lawsuits on fronts covered by the ESG standards.
Popularity. Companies that implement ESG standards are often published in annual reports by companies such as Goldman Sachs, Wells Fargo and JPMorgan Chase, which can drive interest for investing in ESG companies.
2 drawbacks of ESG investing
Despite having some positive sides of ESG investing, there are some things to keep an eye on.
Lack of ESG ranking standards. Multiple companies track and rank companies based on their ESG policies. This can create inconsistency as not every company would be ranked the same, which may cause investor confusion.
It can be misleading. Companies can game the system by ranking high on one or two of the ESG parts. For example, an oil company ranks poorly on the environmental side, but it can boost the social and governance parts to get a high ESG score.
ESG vs. socially responsible investing
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.
Socially responsible investing:
an investing strategy that aims to generate both social change and financial returns for an investor.
3 steps to start ESG investing
Investing in ESG companies and funds is simple. Here’s how to do it:
1. Figure out what ESG and social responsibility means to you
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.
2. Choose to DIY or go with a robo-advisor
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.
3. Find the right ESG company and invest
Now that you know what to look for, here’s how to invest in the right company:
Research ESG stocks. Start by searching the companies online or through your broker.
Open a brokerage account. Some brokers, such as Interactive Brokers, show an ESG score for each company that’s ranked. If you don’t have a brokerage account, consider one that provides ESG scores.
Fund your account and buy the stock. Once you have the funds, go ahead and buy the companies you want.
ESG ETFs
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.
Compare stock trading platforms
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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Kliment Dukovski is a personal finance writer at Finder, specializing in investments and cryptocurrency. He's written more than 700 articles to help readers compare the best trading platforms, understand complex investment terms and find the best credit cards for their needs. His expert commentary has been featured in such digital publications as Fox Business, MSN Money and MediaFeed. He’s also well-versed in money transfers, home loans and more — breaking down these topics into simple concepts anyone can understand. In another life, Kliment ghostwrote guides and articles on foreign exchange, stock market trading and cryptocurrencies.
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