This Is the Hidden Link Between Your Retirement Fund and Global Warming

Company-sponsored 401(k)s are an investor's bread and butter. Money invested in one grows tax-free, can help reduce your tax liabilities, and might be matched up to a certain percentage by your employer.

But if there's one criticism leveled against 401(k)s, it's their lack of investment choices. Unlike taxable accounts through a stock broker, you won't find every asset -- like crypto -- available in a 401(k), nor will you find the full range choice associated with stocks and mutual funds. That might not matter much if you don't follow a strict investment philosophy. But for those who do, one gap in investment choice may become hard to ignore: the lack of mutual funds for ESG investors.

What is ESG?

As a reminder, ESG is an investing approach that elevates three non-financial standards -- environmental, social, and governance -- alongside financial criteria that have traditionally guided investors. It's considered an ethical approach to investing, as it takes into account how a company is impacting the environment and broader society and what decisions its leadership is making to promote positive change.

While ESG investing has been accepted into the investing community, it hasn't quite caught on in 401(k) plans. In fact, less than 5% of 401(k) plans have ESG-dedicated funds, according to Plan Sponsor Council of America's latest member survey. Despite roughly 89% of 2022 investors -- a rate that's up from 84% in 2021, according to a study by Capital Group -- integrating ESG into their investment approach, 401(k) providers have lagged significantly behind.

One reason it might be difficult to find a 401(k) with ESG options is that for a time, the Trump administration proposed regulation that would bar many employers from providing them. Even though the Biden administration recently vetoed that regulation, it might take some time before employers feel comfortable including them.

Does that mean your 401(k) is enabling fossil fuel extraction and global warming?

It would be a stretch to pigeonhole all 401(k) investors as fossil fuel enablers simply because they don't have ESG options. At the same time, it might be difficult for some 401(k) investors to totally divest of fossil fuel companies, especially if they don't have many options in their 401(k).

Now, one caveat I'll add is that many of the largest companies -- whose stocks a 401(k) fiduciary would likely take note of -- are also the leading investments in numerous big ESG funds. Consider, for example, the Vanguard ESG U.S. Stock ETF, one of the largest ESG ETFs. Its principal holding includes companies you're probably familiar with: Apple, Microsoft, Amazon, NVIDIA, and Tesla. These are also five of the largest companies by market cap in the S&P 500, so a mutual or target fund that follows that index would already be invested in some ESG stocks.

But -- stepping back for a second -- it's not even clear what a pure ESG mutual fund would even look like. The companies mentioned above, for instance, are big tech companies that use copious amounts of energy -- not all verifiably clean -- to produce and maintain their products. Even Tesla is hardly the golden standard of environment friendliness, as its high demands for batteries enable environmental degradation through the mining of lithium, cobalt, nickel, copper, and other critical metals.

How to work toward a greener portfolio

One thing we can agree on, however, is that if your current 401(k) investments include companies in the fossil fuel industry -- or dependent on them -- your portfolio isn't purely green. One way to tell is to examine your 401(k) mutual funds with a free online screener, which could show if your fund has any companies that carry a low ESG rating. Alternatively, you can open a taxable brokerage account (or an IRA) through any number of great brokerages and invest in ESG funds that way.

If ESG investing is important to you, it might be worth reaching out to your employer and letting them know you'd like more options. While it might take some time before employers are less hesitant about ESG funds, some pressure could accelerate their acceptance.