“ESG” investing is coming to a 401k or IRA near you. How will it affect your retirement?

“A new DOL ruling would ease existing restrictions on environmental, socially conscious investing by fund managers. Unfortunately, the track record for these funds is not that impressive so far.”

If you’re like most Americans, the reasons you put money in your company’s 401k or IRA are pretty straightforward. You want to grow your wealth, save for the future, get tax breaks, and eventually, have enough to finance your retirement. You trust your employer to offer you the right mix of mutual funds and other vehicles, and, more importantly, you trust the plan’s decision-makers to act as fiduciaries. A fiduciary is someone legally, morally, and ethically obligated to put their clients’ best interests ahead of their own.

United States Department of Labor
United States Department of Labor Sign

According to Department of Labor (DOL) rules, every employer-sponsored qualified plan must have at least one fiduciary. This person could be a trustee, investment advisor, administrative committee member, or another person with discretion in administering the plan.

Your company’s fiduciaries have crucial responsibilities and must adhere to a strict standard of conduct because they act on your behalf. They are making investment decisions that will ultimately impact your retirement for better or worse. The people running your plan are supposed to follow all ERISA-compliant plan documents and ensure that the program is, and remains, diversified.  They are also charged with keeping the plan’s costs reasonable and necessary.

Employee Retirment Income Security Act
Employee Retirment Income Security Act

Before the current DOL rule interpretation, the department’s longstanding position had been that those in charge of 401k and other qualified plans were never to sacrifice investment returns or take on excessive risk to promote social policy goals. In other words, your 401k advisor was not supposed to put your money at risk simply because they believe a specific company, profitable or not, to be socially responsible. However, a new DOL ruling handed down in November could change all that.

The DOL reversed Trump and decided to promote ESGs in qualified plans.

Qualified Retirement plan
Qualified Retirement plan

Climate activists, many of whom are rushing to push a green agenda, saw DOL rules implemented during the Trump Administration as a hindrance to their objectives. Ultimately, most of these activists favored limiting investor choices to only those companies deemed responsible based on corporate policies and non-standard “ESG” (environmental, social, and governance) ratings.

Many people may not understand, even those who pushed the DOL to change its stance on ESG investing, that these ratings do not truly measure a company’s impact on the planet. Instead, they measure the world’s potential impact on the company and shareholders.

Casual investors, perhaps misled by marketing material bragging about a company’s commitment to ESG principles or sustainability, may believe that investing in a company with a high ESG rating helps save the environment. This misunderstanding is bound to influence plan fiduciaries, who might select companies with high ESG ratings only to discover that despite a company’s lofty statements about their goals may not indicate a legitimate commitment to improving the environment.

Worse yet, for those about to retire, their company plan administrators might fill the retirement matrix with corporations highly rated for ESG but which are unprofitable.

Although there are campaigns to make ESG ratings more uniform and measurable, they remain somewhat suspect. Today’s ESG ratings could be effectively useless and little more than marketing tools spun any way the corporation wants.

The DOL ruling comes when ESG investing has seen an uptick in popularity. Companies sometimes felt pressured to offer more highly-rated ESG offerings but were hesitant due to their fiduciary duties. The DOL’s final rule clarifies that retirement plan fiduciaries may now legitimately consider environmental, social, and governance factors when exercising their shareholders’ rights. It paves the way for “socially-conscious” funds’ inclusion in the company’s qualified plan offerings. (You can read the full DOL ruling here):


Have a company 401k or IRA? What you need to know about ESGs.

401K Statement
401K Statement

ESG investing has contributed to the confusion surrounding socially responsible investing. Although many asset management firms tout ESG investing as having the potential to deliver greater returns, that assertion has yet to be proven.

Also, much of the academic research on ESGs fails to demonstrate that investing in ESGs creates higher returns. ESGs are more expensive, typically charging fees 40% greater than traditional funds. Many financial experts insist these fees are unnecessarily costly and unsupported by performance, especially considering an ESG fund’s tendency to mirror other funds. For example, several large ESG funds are as much as 99% correlated with the S&P 500 yet charge more significant fees than traditional funds. However, since assets under management (AUM) revenues have fallen in the last few years, the heftier costs of ESGs may be an attractive way for asset managers to compensate for revenue shortfalls.

Conclusion: If you are a retiree or pre-retiree, you must become involved in your financial future. You need to be particularly aware of threats caused by an evolving regulatory environment. The new Biden regulation will likely open the way for money managers to consider ESG factors in default investment decisions and proxy voting. This shift may or may not be something you want from your retirement plan managers, especially if you are close to retirement or are a more conservative investor.

If you are concerned that ESG funds are not the best place for your 401k dollars, talk to your financial or retirement income advisor about alternatives such as rolling your 401k plan to an annuity or creating a “self-directed” (SDIRA).

And if you want more information about “safe money” alternatives to ESGs, contact me today, and I will be happy to help.

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