5 Big (and Common) Mistakes ESG Investors Make — Are You Making Them?
Are you a proud ESG investor? You should be proud — way to stick by your principles! However, you could make some serious mistakes when you invest sol...
When you get it right, you get it right. You find the right investments that match up to your ESG (environmental, social, and governance) preferences and you invest. You make lots of money and retire with fistfuls of it in each hand (and even more in your investment accounts).
However, the reality might look much different. Let's take a look at the ESG investing mistakes you may be making right now or may be about to make with an ESG portfolio.
What is ESG Investing?
Environmental, social, and governance investing consider an investment's financial returns and overall impact. Just for clarity's sake, let's go over the definitions of each:
- Environmental: You might take a look at how a company treats the environment when you're concerned with environmental principles. For example, you might ask yourself questions like this: How does a company treat greenhouse gas emissions? Does the company create sustainable products? Does it use natural resources responsibly? Does it recycle?
- Social: The social component refers to how a company handles social trends, labor, and politics. For example, a company might be a staunch proponent of community development, equal hiring practices, and prizes human rights.
- Governance: Governance considers all aspects of a company's leadership, executive pay, audits, shareholder rights and internal controls. You want to know as much about how the leadership of the company operates to understand this component of ESG.
It all sounds good, right? However, let's take a look at how investing in ESG could all go south quickly.
Mistake 1: Choosing the wrong broker.
You have to choose a broker in order to invest. Take these steps into consideration: Consider what you want to accomplish, what a broker offers and learn the fees. Check on the following fees:
- A fee for opening an account
- Deposit minimums
- Annual or monthly account maintenance fees
- Minimum account balance requirements
You might find other fees, such as inactive account fees. The bottom line: Check the fees and all the details related to the broker so you don't make the wrong broker decision.
Mistake 2: Not doing your homework.
When you choose an ESG investment, you still need to understand the companies that make up the fund. For example, if you choose an ETF, you want to look into what makes up the ETF, not just its historical performance and other performance details. For example, some people have a tendency to Google "popular ESG ETFs to buy now" and read through what Google has to say on the topic.
That's a great start, but remember that you still need to know what makes up the iShares MSCI KLD 400 Social ETF (DSI), for example. Learn as much as you can and dissect every company that makes up that particular ETF (or whatever type of fund you're interested in).
Mistake 3: Falling for the love of the cause — not the companies' underlying potential.
A big mistake ESG investors make: Liking the ESG elements — and that's it.
For example, let's say you specifically prefer investments related to treatment of animals. You research investments that don't test on animals. You look for funds that clearly state in their prospectuses that they exclude companies that engage in or are involved with animal testing.
You might be tempted to forget to look into its sectors and how they're weighted. You might not look into the underlying success of each company. Not looking into company fundamentals can signal bad news for your investment.
You may even gloss over what type of fund you buy (a mutual fund versus a less expensive ETF) because you like what you've read about the fund. A less expensive ETF might make more sense.
Mistake 4: Not considering your risk tolerance.
When you look for ESG investments, you may throw all caution to the wind with regard to risk tolerance because you focus on the ESG factors themselves.
Do you know your risk tolerance and how much volatility you can handle over time? (Volatility refers to how much an investment moves up or down over a period of time. Investments will experience more volatility over the short term compared to the long term.) If your investments are not aligned with your risk tolerance, you may be more likely to make a poor investment decision.
Again, don't get so hung up on the ESG components of your investment that you forget about other factors.
Mistake 4: Adopting a set-it-and-forget-it approach.
Have you ever bought into an investment, then never monitored it? That's a mistake, and here's how it could play out. Let's say you like the idea of choosing a number of investments related to energy use, waste, natural resource conservation, and animal treatment. You find the perfect funds. They check all the boxes, and you hand over your hard-earned money.
You might not realize you need to reallocate or rebalance periodically to a target asset allocation. You might need to sell high and buy low and check volatility levels.
You should sell your best-performing investments and buy those that have not performed as well. If a portfolio never rebalances, stocks will eventually make up a larger portion of the portfolio. That might not be your original intent at all.
Mistake 5: Not broadly diversifying.
You might be way too concentrated as an ESG investor. You may assume you're getting broad diversification when you invest in say, an ESG ETF, but you may not be. Even if you invest in several funds, your money could go into just one sector.
Again, pay attention to the underlying makeup of the fund so you know what you're putting your money into.
Make Great ESG Decisions
ESG investing offers a great, noble opportunity to invest in causes you care about, but remember to avoid big mistakes as you hone in on these causes. If you're not sure you're making the right moves (particularly if you're a first-time investor), consider consulting a professional for guidance.
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