How advisors can help clients invest sustainably outside of 401(k)s

This article is part of a series that provides a framework for incorporating sustainable investing into your advisory practice.

My previous column, “How Advisors Can Help Clients Invest Sustainably in Retirement Accounts,” explored the limitations and opportunities of sustainable investing within employer-sponsored retirement plans such as 401(k)s. Advisors who support clients in sustainable investing outside of these accounts may find more choices, but also more complexity.

Taxable brokerage accounts and IRAs

With taxable brokerage accounts and IRAs, investors are not limited in their stable investment options as they typically are in employer-sponsored retirement plans. Brokerage platforms can host a wide and growing range of stable index funds, mutual funds and exchange-traded funds. The downside of choice is that it can be difficult to assess how investment products labeled “green” or “social” are actually performing on sustainability metrics. Investors can assess the sustainability ratings of public funds using free screening tools such as As You Sow, Ethos, and USSIF’s Sustainable Mutual Funds and ETFs Chart. Advisors can also use Morningstar’s Sustainability Ratings, the subscriber version of Ethos for additional capabilities such as custody linking, and YourStake’s subscription-only review platform that also allows for custody linking to client accounts for a complete portfolio assessment.

Fixed income impact investments through publicly listed offerings, such as LISC Impact Notes, Capital Impact Investment Notes and the Calvert Community Investment Note, are investable through taxable accounts and standard IRAs. To learn about private investments based on equity building, such as Community Land Trusts, community loan funds, and direct investments in cooperatively run businesses, consider The Next Egg, which is a community subscription-based online learning. Some traditional custodians allow private investments on their platforms within taxable or standard IRA accounts, especially for large account holders.

If you have a client with a specific alternative investment that you are not sure can be held in their account, contact your custodian’s alternative investment team. They may review and approve the alternative investment, or may be able to work with the alternative investment provider to approve holding the investment on your custodial platform.

Self-Directed Retirement Accounts

Future Egg also has resources for using self-directed retirement accounts. A self-directed IRA, or SDIRA, can hold nontraditional private investments, such as community loan funds, real estate, and investments in local businesses. It’s important to note that SDIRAs come with additional administrative fees that standard IRAs typically don’t charge.

There are two types of SDIRAs: custodial and checkbook. Each differs in the level of independence and responsibility required of the investor. In the SDIRA custodian, the custodian where the account is held executes the transactions, handles account administration, and can limit what investments are available on their platform beyond IRS rules. In a checkbook IRA, the account is held in an LLC or trust. The IRA account is the sole member of the LLC and, therefore, has decision-making capacity. The account holder carries out the transactions themselves and manages the account, which includes bookkeeping, filing tax returns and filing annual reports. The account holder does not need approval of what they invest in, although they must still stay within IRS rules.

Consider minimum investment thresholds

It is possible to practice sustainable investing for clients across the spectrum of income and wealth, but not without limitations beyond the type of accounts they have access to. There is also the reality that Americans in the 10% of net financial worth own 84% of all Wall Street investments. About half of Americans don’t own any stock investments, and a third don’t have access to an employer-provided retirement plan. Those who may have some ability to save may also need to prioritize medical debt, student loan debt, and rising housing costs over investing for the future. I have seen people of all ages leave or disengage completely from the capital markets due to a combination of these obstacles and challenges.

Some private investments require accredited investor status, and the minimum investment requirement for sustainable public investments can be as high as $3,000 for some mutual funds in taxable accounts. One of the benefits of investing within an employer defined contribution plan or IRA is that mutual fund minimums are usually waived. However, there is a growing universe of sustainability-focused ETFs where the minimum investment is the price of a share.

Outside of funds, direct indexing allows investors to track the performance of an index by directly owning the collection of individual holdings rather than a linked index fund. The technology was available to advisors and individual investors through OpenInvest before its sale to JP Morgan in 2021. Other large custodians are moving in this direction. Vanguard acquired Just Invest and is offering its direct index portfolio management tool directly to advisors. Advisors can use similar investment customization technology for their clients through companies such as Ethic and Vise. Etika acts as a sub-advisor and works with advisors to apply environmental, social and governance screening data to exclude undesirable companies from portfolios based on client sustainability preferences. Vise supports advisors in customizing client portfolios based on a set of financial and non-financial filters, such as industry type. Morningstar is also launching a live indexing tool for advisors. With direct indexing, there are often minimum account balances set by the provider.

Steady investing outside of custodial accounts

For investors without access to an employer-sponsored retirement plan or account that holds the investments they want, sustainable investing is still possible. IN Put your money where your life is (2020), Michael Shuman wrote about investing in and out of custodial accounts, such as directly in your home and local community. Best banking options and strong deposits are two ways to evaluate banks and credit unions.

Investors can also look after private or direct community investment. Most of the impact investments available to retail investors are in the form of unsecured promissory notes that pay a fixed interest rate for a term chosen by the investors, as in the case of impact investing through CDFIs. It is not necessary to possess promissory notes within an escrow account as they can be purchased directly through the organization.

One drawback of holding individual records outside of custodial accounts is giving up potential tax benefits such as tax deferral or tax-free growth available in retirement accounts. There’s also the account management responsibility that comes with self-care, such as keeping track of credit and purchase agreements and tracking interest payments over time. These activities can become overwhelming as the number of private impact investments in a portfolio increases. One way to stay organized is to pay periodic interest into a dedicated account so the investor or advisor can keep track of these payments for tax reporting as well as manage the reinvestment of the funds. Another option is to have the interest automatically reinvested in the note and paid only at maturity along with the principal.

Making sustainable investments more accessible

Answering the question “Where and how can investors invest sustainably?” it depends on how the investor defines sustainable investing, their financial resources, and the types of accounts and investment choices they have access to. And, as always, your recommendations as an advisor should align with your clients’ short-term and long-term goals.

Both investors and advisors can have a hand in increasing access to sustainable options for themselves and future generations of investors. In my next column, I’ll explore how advisors can identify and evaluate sustainable investments to mitigate greenwashing and ensure the strategies they’re applying to client portfolios are meeting their financial and impact objectives. .

About Morningstar, Inc. Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia and Asia. The company provides a broad line of products and services to individual investors, financial advisors, asset managers and owners, retirement plan providers and sponsors, and institutional investors in the debt and private equity markets. Morningstar provides research data and insights on a wide range of investment offerings, including managed investment products, publicly listed companies, private equity markets, debt securities and real-time global market data. Morningstar also provides investment management services through its investment advisory subsidiaries, with approximately $251 billion in assets under advice and management as of June 30, 2021. The company has operations in 29 countries. For more information, visit Follow Morningstar on Twitter @MorningstarInc.

Phuong Luong, CFP, is an educator and financial planner focused on economic justice and closing racial wealth divides. She is a principal at Saltbox Financial, a virtual, fee-only RIA. She is also an online facilitator for Boston University’s Financial Planning Program. Phuong is a subject matter expert in ESG and regenerative investing. Follow Phuong on Twitter: @pt_luong The views expressed in this article do not necessarily reflect the views of Morningstar.

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