ESG or Environmental, Social, and Governance Criteria include standards which you can use to screen investments to ensure they are socially and environmentally responsible. For the socially conscious, it’s easy to see why an ESG considerations would factor heavily in how and why you invest. You want your money to make a difference, not to fossil fuel companies, bad actor companies, etc. Paying attention to Environmental, Social, and Governance scoring during asset selection can allow you to be socially conscious with your 401(K) investments.
This article will go over what ESG is and how you can work to leverage it for your 401(K).
What is ESG?
Environmental, Social, and Government Criteria are normally used to map investment opportunities according to a point scoring system. Opportunities that score well are ranked based on environmentally friendly business practices and operations, socially responsible behavior, and good governance practices. These normally translate to points like:
- Carbon Positive/Carbon Neutral
- Engaging in sustainable business activity
- Investing in ecology and environment
- A green or renewable industry (E.g., solar panels)
- Company diversity
- Company policy
- Impact on employees (fair treatment, fair wages, retirement plans)
- Impact on surrounding residents and populace (E.g., pollution, impact on job market)
- Diverse board composition
- Shareholder friendly policies
- Strong oversight
- Resource use
- Emissions
- Innovation
- Human rights
- Investment in community
- Product responsibility
- Corporate Social Responsibility (CSR) strategy
Many organizations use slightly different systems, but some of the most popular include the Morningstar Sustainable Investment List, Fidelity Sustainability Fund, and similar. Many are independently researched and scored by brokers.
On every case, an asset with a strong ESG rating has been shown to invest in and engage in environmentally, governmentally, and socially ethical and sustainable practices. The extent to which either of these apply depends on the scale. However, this tends to automatically rule out bad actors, fossil fuel companies, etc. You choose how and where you put your money to support your system of beliefs.
How to Leverage ESG for Your 401(K)
While millions of Americans are likely open to investing in environmentally and socially sustainable assets as part of their portfolio, options are often lacking. In fact, the American Retirement Association’s Plan Sponsor Council of America’s 62nd Annual Survey, just 2.9% of 401(K) plans offer ESG options. Furthermore, just 0.01% of all assets are ESG.
That lack of availability is further complicated by the October 2020 Department of Labor Ruling, limiting ESG activity in retirement accounts. In short, the ruling limits the amount to which you can consider environmental and social factors when choosing investments for retirement versus financial viability – essentially meaning your financial choices must be significantly stronger. While this regulation might be reversed, especially as the Environmental Protection Agency gains more power, its impact, for now, is that ESG options are very limited for your standard 401(K).
Therefore, ESG investment with a 401(K) is not your best choice. Instead, your best option is to choose the self-direct brokerage option known as the Schwab Personal Choice Retirement Account (PCRA).
What is a Personal Choice Retirement Account?
A Schwab Personal Choice Brokerage Account is a self-directed brokerage account (SDBA) residing inside your employer-sponsored 401(K) plan. The PCRA offers numerous advantages, including self-direction, a significantly wider selection of investments, and the full freedom of a brokerage account. However, it is bound under several restrictions:
- Your employer must offer the PCRA for you to open an account
- Your employer sets investment scope to include either “most” available investments or “mutual funds only”. In the latter case, it’s unlikely to be a top choice for ESG investment.
- Your total retirement plan might still limit investment types
- Money must be transferred from your retirement plan to the PCRA
- PCRAs require significantly higher maintenance and management. You might want a personal account manager to handle assets, diversification, and balancing.
Depending on your employer, a Schwab Personal Choice Retirement Account might be completely fee free. You might also pay account and maintenance fees. Normally, it’s a good idea to talk to your account manager, check employer offerings, and see what’s available.
However, most Schwab PCRA accounts will allow you to invest in a full range of ESG assets, including those discouraged under the new Department of Labor regulation. If your employer allows most available assets, you could invest in the full-available Morningstar, Inc.® “Sustainable Investment list as part of your retirement. This could, in turn, allow you to create significant social and environmental impact with your retirement savings.
Moving to a More Sustainable 401(K)
While a PCRA allows you much more personal freedom in investing with your 401(K), it’s critical to plan and use the right strategy. Critics of ESG rightfully point out that people newly investing in ESG assets often make the mistake of diversifying into very similar assets. Environmentally sustainable assets carry the same risks as any other investment. It’s important to review financial viability, long-term stability, and to diversify your assets to prevent loss in case of a crash. Most individuals will heavily benefit from an asset and account manager who can collectively weigh various assets to make those decisions.
- If you’re choosing from an ESG list, it narrows options. Data shows that narrowing financial options increases the risk of financial blunders. It’s critical to take more care and involve more planning to prevent losses. ESG investments aren’t all increased risk. In fact, with government regulation increasingly shifting towards promoting and subsiding environmentally and socially sustainable business practices, some could be safer than non-ESG.
- Check any tax implications of moving funds out of 401(K) and into a PCRA. E.G., if taxes are currently high, other structures with more limits and less opportunities for ESG investments might be a better personal financial fit. You might also find a balance by spreading 401(K) between a Roth and PCRA account.
- PCRA accounts are available as 401(K) PCRA and 457 PCRA. Both can be advantageous depending on your situation and employment situation. However, you cannot transfer money between the two.
Switching at least some of your 401(K) strategy to a Schwab Personal Choice Retirement Account will give you more freedom, more personal choice, and more portfolio diversity. It will open up opportunities for investing in ESG assets, simply because it’s personal choice and significantly less effected by the Department of Labor regulation or the lack of real ESG options in most 401(K) accounts.
If you’re ready to move forward with environmentally and socially friendly investments, contact us today. The retirement planning experts at Tangent Retirement can assess your finances to determine if a PCRA is right for you and then help you build the strategy to make it work.
This information is for reference only and should be reviewed with a qualified professional as you situation may vary from others. Nothing mentioned above is a guarantee nor should this be considered advice.
Golden State does not and cannot deliver tax advice and the material herein is for information only. Please consult a qualified tax professional for opinions related to your particular situation.
Investment advisory services are offered through Golden State Equity Partners, LLC, an investment adviser registered with the U.S. Securities and Exchange Commission. Tangent Retirement is a DBA of Golden State Equity Partners, LLC.
