Yes, You Can Align Your Pursuit of Early Retirement With ESG Ideals. Here’s How. – Barron’s

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Interest in ESG investments has exploded over the past few years among individual investors who are concerned about the impact of their investments, helping drive short-term outperformance. But some observers question whether such investments can deliver the longer-term market-beating returns that would likely be required by investors who are pursuing financial independence or looking to retire early.

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Cody Garrett, a certified financial planner at Houston-based Measure Twice Financial, isnt surprised that environmental, social, and governance investments have piqued the curiosity of his clients who are FIRE adherents. The philosophy behind financial independence is aligning financial objectives with personal values, he says. That closely mirrors the mindset of many ESG investors. The FIRE community is waking up to what their investments are supporting and how their money is being used.

But does restricting investment options to socially responsible assets hinder FIRE plans, where the ultimate goal is to maximize returns for the long haul?

Garrett says no, and he has some tips for aligning a FIRE portfolio with ESG tenets:

ESG for the right reasons: ESG funds are often overweighted with growth stocks that tend to be more ESG-compliant, such as big tech. These funds handily outperformed the broader stock market during the pandemic, Garrett says, though he warns that the lead may not be sustainable as value stocks recover.

That said, he believes large market cap-weighted ESG funds will likely remain closely correlated to their non-ESG counterparts. Why? As ESG funds make exclusions, they push more assets into the biggest companies by market cap, including big tech, which can help their performance relative to non-ESG funds, Garrett explains.

I think a lot of people are tempted to move into the ESG space because theyre attracted to the short-term gains made over the last year or so, Garrett says. Yet he cautions investors against the temptation to chase returns. What happens if ESG ends up underperforming, are you, as an investor, going to change your mind? he asks. The decision to use ESG should be a decision to align your money with personal values, not merely a financial choice.

Choosing funds. There is no consensus definition of an ESG asset. A particular company could excel in environmental issues while falling short at corporate governance. Whats more, ESG funds set their own criteria of inclusion or exclusion.

To know for sure whether investments match individuals values, investors have to take a look under the hood. The funds prospectus will explain its methodology, and Garrett recommends looking at Morningstars sustainability rating, which is continually improving, so theres more consistency, he says.

Ditch the one-size-fits-all approach. When considering the individual goals and values that bring people to the FIRE movement, the advice they receive is often strikingly generic: Put your money in a low-cost index fund and wait. The strategy is sometimes known as VTSAX and chill, referring to the Vanguard Total Stock Market Index Fund Admiral Shares commonly used by FIRE investors.

ESG strategies are inherently more varied, and Garrett encourages his FIRE clients to branch out and build a portfolio that better reflects their individual values.

When building out the equity portion of an ESG portfolio, Garrett recommends a core and explore strategy. Practically, that means a core investment representing about 90% of the equity portfolio that includes broad ESG index funds. These funds are typically based on broad-market indexes and exclude stocks that dont meet their ESG criteria, like petroleum companies, for example.

For Garrett, the remaining 10% of the equity portfolio represents a chance for clients to explore specific funds or sectors they are passionate about, such as alternative energy or funds that invest in women-led companies.

Write to retirement@barrons.com

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Yes, You Can Align Your Pursuit of Early Retirement With ESG Ideals. Here's How. - Barron's