5 steps to retrofitting your retirement strategy for climate change

What began as a principled way to invest has now been validated as a profitable way to invest. Over the last decade -- and through the first quarter of 2020 -- data shows that investment funds assembled with sustainability in mind have outperformed traditional funds. 

Analysts at market research firm Morningstar (PDF) looked at the average returns of nearly 4,900 European funds, including 745 so-called "sustainable" funds, and concluded that "there is no performance trade-off associated with sustainable funds." In fact, sustainable investments deliver a premium to investors.

Financial planners say that such evidence should reassure investors who may have been skeptical about the viability of sustainable investments or funds that focus on ESG -- that's environmental, social and governance -- issues. "The history of performance continues to grow and look good," says Hilary Hendershott, founder of Hendershott Wealth Management in San Jose, California. "In the past, the common wisdom said that values-infused investments would require you to give up performance -- but that's no longer the case, based on historical evidence." 

Intrigued? Financial planning experts recommend the following steps toward building a more climate-friendly portfolio.

Begin with some research

Sustainable investing is rapidly growing. Bloomberg Intelligence forecasts that the asset class will increase to $53 trillion by 2025. But within that sector, there is still no single governing body to provide an ESG stamp of approval -- or audit companies to ensure they're living up to their commitments. For now, that work remains left to financial institutions and advisors, which may not always be in the best position of expertise. So, before selecting investments, research the funds -- MSCI and Morningstar are reputable sources -- and talk to knowledgeable professionals who can help inform your decisions, such as a 401(k) plan provider or a certified financial planner.

"Climate is consistently coming up as the top investor issue," says Amy O'Brien, head of responsible investing at Nuveen, a TIAA company where investors have access to various ESG-type stock funds through their employer-sponsored retirement plans. "It's up to firms like ours to educate people -- to get people engaged."

Consider your plan first, portfolio second

Impact investing may not be for everyone. Depending on your personal goals and retirement timeline, you may only want to dip a toe -- or go all in. "It really depends on your financial plan," says Georgia Lee Hussey, a certified financial planner and founder of Modernist Financial based in Portland, Oregon. "What are your goals, where are your assets now, and are you saving aggressively to be able to meet those goals?" People who can answer yes may be in a better position to reallocate their investments towards sustainable funds. Otherwise, consider assembling a more diversified, evidence-based portfolio that tracks the broader market -- until you feel more prepared to make a transition. 

Don't overcomplicate it

Once you're ready to embrace a sustainable investment strategy, you have many options from which to choose. "Sustainable" or "impact" investments that track companies in one -- or all -- of the E, S and G categories are widely available. And however you invest -- whether through a retirement account (such as a 401(k), 403(b) or individual retirement account), an online brokerage or a robo-advisor (like Betterment or Aspiration), there will be pre-vetted mutual funds and ETFs, says Hussey. "I would recommend sticking to what is easy," she says.

Note that sustainable funds may not address a combination of environmental, social and governance issues. Some may focus exclusively on environmental issues, for example. To further simplify your strategy, it may help to select one area to follow and track, such as companies that support carbon neutrality or renewable energy.

Do eye the fees

Like mutual funds, most sustainable investment funds charge fees -- often presented as an "expense ratio" -- that cover operating and administrative costs. And these fees can eat away at your returns over time. While you may not be able to avoid them entirely, keeping them to a minimum is critical. If possible, select a fund that charges 0.5% or less. A 2020 Morningstar report (PDF) underscores the importance: "Fees are a crucial consideration when selecting a sustainable fund. Lower-cost options tend to have greater odds of success."

Prepare for volatility

ESG investing has proven itself to be financially sound -- but like any investment, results vary from quarter to quarter and year to year. For those who have decades left to build a retirement fund, short-term results are far less important than the long-term ones. "Remember that as investors, we take a long frame. Over the long haul, we believe that companies that are considering their climate impact are going to do better over the long run," says Hussey.