You recycle, ride a bike whenever possible, avoid products with excessive packaging, and never let the faucet run while brushing your teeth. Given the opportunity, you'd love to align your eco-conscious approach with your financial goals by supporting companies that prioritize sustainability. But the last time you looked, your 401(k) fund options ranged from target-date funds to index funds -- without a hint of sustainability to be found.
The good news is that may be changing. Sustainable investing is on the rise, and only partly because more people care about corporations' environmental, social, and governance (ESG) practices. The other factor is an increasing recognition that companies with solid ESG track records can also produce competitive financial results.
Traditionally, the mainstream investment community has accepted the conclusion that corporate sustainability efforts hurt financial performance. That's one reason why so few 401(k) plans offer retirement savers sustainable investment choices: Plan administrators are worried about violating their fiduciary duty to protect the participants' retirement assets.
Knowingly introducing a dud fund to the 401(k) could be such a violation. But it's tough to argue that all sustainable funds are duds because the numbers tell a much different story.
Sustainable practices are linked to resilience in market downturns
A look at ESG indexes, which include securities that meet certain sustainability criteria, shows that eco-friendly corporations are holding their own. In the 12 months ending June 5, 2020, the S&P 500 ESG index produced an annualized return of 13.38%. In the same period, the S&P 500 returned 13.01%. According to Morningstar, 89% of its ESG indexes outperformed their broader market counterparts in the first quarter of 2020 -- when the S&P 500 lost 30% of its value in the coronavirus sell-off. Further, a BlackRock study found that more than 75% of sustainable indexes had less downside than their traditional equivalents during market dips between 2015 and 2018.
If anything will convince 401(k) plan administrators that sustainable funds are responsible investment vehicles, it's a solid track record of performance. You can also do your part to encourage another look at sustainability. Call up your administrator and request the inclusion of sustainable fund options in that retirement plan.
How to get started with sustainable investing
In the meantime, you'll have to support sustainable corporations outside of your 401(k). Your traditional or Roth IRA is a good place to start, since you can buy individual securities, mutual funds, and exchange-traded funds (ETFs) in those accounts. The simplest approach is to seek out ESG funds or ESG ETFs. These funds build portfolios from companies that meet minimum sustainability standards.
Start by looking for large, established funds with low expense ratios. iShares ESG MSCI USA Leaders ETF (SUSL -1.55%), for example, has $2.31 billion in assets under management (AUM) and a net expense ratio of 0.10%. Another popular choice is Vanguard ESG U.S. Stock ETF (NYSEMKT: ESGV), with AUM of $1.48 billion and a net expense ratio of 0.12%.
Narrow your options further by reviewing each fund's evaluation strategy. You should find this in the fund description and in the prospectus. It's worth stating the obvious here: The presence of ESG in the fund's name does not automatically mean the portfolio lives up your values and worldview. Some ESG funds will outright exclude companies that participate in certain undesirable industries, like tobacco or gun manufacturing.
Other ESG funds take a more measured approach by supporting companies that have better ESG track records than their peers, with a reduced emphasis on lines of business. That's why you might see oil and gas holdings, for example, in an ESG portfolio.
Follow best investing practices
As with all your investment choices, question how an ESG fund fits into your overall plan before you buy. While the strongest ESG funds have performed well in recent downturns, they're not without risk. Most are equity funds that are best combined in a portfolio with debt securities for added stability, depending on your age and risk tolerance.
Support your values and financial goals
You can align your values with your financial goals, even if you have to do it outside your 401(k) for now. Know that ESG funds vary widely in their approaches, and do the research to ensure you invest in those that meet your personal standards.