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ESG Investing in Your 401(k) Retirement Plan: Bridging the Gap Between Theory and Reality

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By Jared Tanimoto, CFP

What’s not to love about investing in a sustainable ESG fund in your 401(k) or similar defined-contribution retirement plan? The answer isn’t as obvious as you might think.

Jared Tanimoto

The idea is appealing: While tax-efficiently saving for your own retirement, why not also make the world a better place by investing in companies with responsible environmental, social, and governmental (ESG) practices? But in reality, ESG investments remain a relative rarity in 401(k) plan offerings. In May 2021, Morningstar reported:

“Although the number of ESG funds available in the industry tripled between 2014 and 2020, we find that still less than 5% of defined-contribution plans include at least one sustainable fund.”

Understanding the 401(k) ESG Investment Gap

There are several reasons for the disconnect between plan participants seeking ESG investments and plan sponsors providing them.

  1. The Department of Labor Is Hesitant: The Department of Labor (DOL) is tasked with ensuring employer-sponsored retirement plans are fulfilling their fiduciary duty to prioritize participants’ highest financial interests. It’s been cautious about welcoming ESG funds into the 401(k) mix, lest plan participants sacrifice available market returns in pursuit of ESG goals. As announced in a March 2021 release, the DOL is neither enforcing a ban on nor affirmatively endorsing ESG investing within 401(k) plans. 
  2. Employers Are Risk-Averse: Employers have moved slowly too. Outside of your employer’s retirement plan, it’s your choice if investing sustainably is more important to you than squeezing every dollar out of every holding. But in the absence of clear regulatory guides, your employer may be reluctant to increase its exposure to expensive legal and regulatory woes by including ESG funds on its standard menu. 
  3. Results Remain Mixed: Is ESG investing actually expected to hurt, help, or make no difference to your end returns? I’d say the jury is still out. For every study or analysis suggesting ESG investing may hurt your end returns, it’s easy to find others refuting this claim. That’s probably in part because it’s difficult to even define what “it” is (as reflected in a recent piece, “What is ESG? Depends on Whom You Ask”).

Bridging the Gap

Hurdles aside, what if you’d still like to invest your retirement dollars in ESG funds? At least until ESG investing becomes more common in 401(k) plans, you might need a creative solution to fill the void.

Rollovers: You may be able to roll over older 401(k) plan assets into an individual IRA account to gain access to more investment options. Be careful about completing a proper rollover, so you don’t incur unwelcome taxes or penalties.

Self-Directed Brokerage Accounts: If it’s allowed, you could set up a self-directed brokerage account within your employer’s retirement plan. This gives you more choices beyond the plan’s limited menu, although you’re also essentially on your own if you make a horrible choice.

Do-It-Yourself Retirement Saving: You could open up a traditional, independent brokerage account dedicated to saving for retirement. You could then invest however you please, although you’d sacrifice any tax-favored status on the holdings.

Plan Before You Proceed

Each of these possibilities may let you invest more sustainably. But each is also fraught with significant investment management and tax planning caveats. Improperly equipped, flying solo can cost you dearly. Plus, even if your retirement plan is among the few with ESG funds in its standard lineup, not every fund is an advisable investment to begin with. So, no matter how you proceed, we strongly suggest doing your due diligence first.

How much will it cost? Beware of excessive fees; they exist among ESG funds as much as anywhere else. How much is “excessive”? With basic index funds available at a tiny fraction of 1%, any expense ratio that pushes near or past 1% should give you significant pause.

Does it fit your investment strategy? Before you start picking particular investments, let’s talk bigger picture. The most dependable way to reach the retirement you envision is to lead with an investment strategy that reflects your financial goals and risk tolerances. Your strategy informs you on how much to allocate between stocks and bonds, and across various factors within each.

Bottom line, remember: The real reason you’re investing toward retirement is to fund your eventual retirement. So, if available ESG funds are costly or don’t fit into your carefully structured strategy, you may want to pass. Consider investing efficiently, and then using some of the returns to donate to the charities of your choice.

However you proceed, don’t lose sight of how important your investment selections will be for this lengthy journey, and choose your “travel companions” accordingly. A one-off consult with an independent financial advisor can go a long way here, to help you accurately assess where you stand.

About the Author: Jared Tanimoto

Jared Tanimoto is CERTIFIED FINANCIAL PLANNER™ based out of Irvine, California and has been working in the financial services industry for over 10 years. He is currently the President of the Financial Planning Association of Orange County and was recently nominated to InvestmentNews’ 40 Under 40 list for 2021. Outside his professional life, Jared and his wife live an active lifestyle with their daughter and enjoy anything that involves the outdoors. www.ascentwealthadvisors.com


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