As an investor, you worry the most about making money; everything else comes next. But what happens when you realize you could not only be doing yourself a favor with your investments but also contribute to other people’s livelihoods?

A growing number of investors are prioritizing financial assets that allow their resources to do good, whether it’s supporting a company with strong environmental values or investing in funds with strict environmental, social and corporate governance (ESG) criteria.

For investors looking to go further with supporting environmental and social causes, donor-advised funds can be a worthwhile option.

Donor Advised Funds (DAF) Explained

Did you know that donor-advised funds represent around 10% of all charitable donations? These vehicles are growing at a fast pace and making a significant difference for non-profits.

Exploring Impact Investing With Donor-Advised Funds

A donor-advised fund pools investments from donors and invests the money in different assets. The fund disburses donations to non-profit organizations after they’ve had enough time to grow.

A sponsoring organization retains legal control of the fund, but donors are involved in the management process. For example, donors have a say in which assets the fund invests their donation in, and they can also choose which non-profits will receive a donation from the fund.

The purpose of this model is to maximize donations. Instead of making a direct donation, money has time to grow in the fund, which results in a larger contribution to the charity of the donor’s choice.

Impact investing is a different concept. This approach to investing is about selecting assets that allow the investor to do good with their money.

Each impact investing strategy is unique and reflects the personal goals and values of the investor. Some impact investors build a portfolio that avoids exposure to sectors like weapons or fossil fuels. Others go further and limit their investments to companies with net zero emissions.

Unlike donor-advised funds, impact investing typically focuses on growing a personal portfolio to support goals like retirement or wealth management.

Donor-advised funds and impact investing have different goals, but it’s possible to apply an impact investing strategy when deciding how to invest.

Limitations for Donor-Advised Funds Working With Impact Investments

Is impact investing the best way to manage a donor-advised fund? The global impact investing market now exceeds $1 trillion, and most investors say this strategy has performed better than expected.

Impact investing is a viable solution for generating revenues and increasing the value of a donor-advised fund. However, there are a few limitations to consider:

Focusing on impact investing means an investor might pass up opportunities in other areas.
A donor-advised fund pools resources from several investors. An investor’s impact investing strategy might have a limited effect on the fund if others invest in markets with poor ESG practices.
Impact investing is still relatively new. Making sound investment decisions can be challenging due to the limited historical data available.

Benefits of Donor Advised Funds

Donor-advised funds are growing fast, with grants issued to charities up by over 28%. Besides generating more donations for nonprofits, DAFs have some advantages for donors:

Your contributions to the fund are tax-deductible. You can contribute at a pace that works for your financial situation.
You can donate cash, stocks, and other assets. Some funds even accept cryptocurrency.
You retain control over how the fund invests your money, with some optional guidance from the sponsoring organization.
You choose which non-profits you want to support by recommending the fund issue a grant to the organization of your choice.
The sponsoring organization typically conducts due diligence to ensure the non-profit you selected is a legitimate charity and uses funds to support its mission.

Impact Investing Explained

Do you belong to the 67% of investors who feel they should make a difference with their money? If yes, impact investing could be right for you.

Benefits

Impact investing is a modern approach to wealth management that reconciles an investor’s interests with social or environmental causes.

The purpose is to build a portfolio that reflects your value and allows you to invest without worrying about your investment strategy supporting activities you disagree with.

Plus, companies with strong ESG practices tend to be more resilient and have a higher potential for growth in the long term. These companies are typically better at managing risks. A study has shown that an ESG-oriented portfolio could yield higher returns than a non-ESG portfolio by 0.17 to 1.25 percentage points.

Limitations

There are a few limitations linked to impact investing:

It’s a relatively new market, and less historical data is available.
Impact investing can limit your exposure to profitable markets with a proven track record of consistent returns, such as the oil industry.
The social and environmental impact of your investment can be difficult to measure.
Selecting assets that align with your values can be challenging. There are ESG stock ratings, but each organization uses different criteria to issue these ratings.
Impact investing can be more consuming in terms of time and resources since there is a thorough due diligence process needed to select assets.

How to Use DAFs for Impact Investing

Donor-advised funds are an interesting addition to an impact investing strategy. For investors who want to make contributions to the causes they care about while benefiting from tax-deductible donations, a DAF can help maximize their impact by letting their donations grow.

The investor can also select assets that align with their impact investing strategy for the DAF.

The Law

Impact investing raises some legal questions. While this approach has significant benefits for the environment and communities around the globe, it doesn’t always align with the strict regulations financial advisors, and other professionals have to follow.

For instance, financial advisors must perform a fiduciary duty toward their clients. This duty includes acting in their client’s best interest and maximizing returns while balancing risks. However, in the context of ESG investments, prioritizing social and environmental benefits over financial returns doesn’t align with an adviser’s fiduciary duties.

Financial professionals must also follow regulations regarding documenting the methodology they use to select assets and balance portfolios. Documenting an impact investment strategy can be challenging since the advisor might have to work with qualitative data to measure an investment’s social or environmental impact.

Terms and Types

There are different approaches to impact investing:

Financial-first impact investing. With a financial-first approach, the investor is selecting assets that will grow their wealth without harming people or the environment.
Impact-first investing. This approach is about maximizing the social and environmental impact of the portfolio. The investor cares less about financial returns and wants to maximize their effect on the environment and society.

Note that investors can build a customized portfolio that aligns with their goals and sits somewhere between these two approaches to impact investing. Adding a DAF to a portfolio can also help offset a financial-first strategy’s limited social and environmental impact through donations.

Socially Responsible Investing

Socially responsible investing is a slightly different approach. With this strategy, investors prioritize assets that support companies with positive social practices.

They might select businesses that respect human rights, create jobs, and run programs to support access to healthcare or education.

Some investors go further by seeking companies that give back to the community or invest in developing the infrastructure in underprivileged areas.

How to Participate in Impact Investing

You can make a difference by rethinking your relationship with wealth management and embracing impact investing. Getting started is easier than you think.

Starting a Dialogue

Who is currently managing your finances? Reach out to your financial advisor or retirement plan manager and ask a few questions about your investments.

Find out more about the makeup of your portfolio, which sectors you’re investing in, and which companies your investments are supporting.

Most businesses with a strong ESG strategy have content detailing their mission and their impact available online. You can also ask your advisor or retirement fund manager how they select new assets for your portfolio and whether they consider social and environmental factors at all.

You can also discuss how shifting your strategy to focus on impact investing would affect your returns and risk exposure.

Reaching Out

Reach out to people who can help you go further with impact investing. It’s a relatively new way of investing, and not all family offices and investment management firms have experience with impact investing.

Look for financial professionals who specialize in impact investing or are willing to learn. You should also reach out to other investors who have embraced this strategy to learn more about their methodologies.

Learn About Philanthropists

Think about adding a charitable dimension to your investment strategy by investing in a DAF or setting aside a portion of your returns for donations.

Learn more about philanthropists in your area and the organizations they support. Approaching these donors to find out more about the methods they use is a great way to learn more about effective strategies for managing your wealth while supporting the causes you care about.

The Relationship Between the Two

While donor-advised funds and impact investing are two different concepts, there is a strong link between the two because they reflect similar values.

A DAF can be an excellent addition to your portfolio if you’d like to use your wealth to do some good. If you’re donating to a DAF, consider using impact investing strategies to pick investments that will support social and environmental causes while benefiting a charity of your choice.

The Bottom Line

Investing for the sole purpose of generating a return is becoming an obsolete way of thinking. Instead, more investors than ever care about making a difference with their asset selection.

Looking into impact investing and donor-advised funds are a great place to start for those looking to have a positive impact at the social and environmental level.