11 Steps to Making Your 401(k) Plan Greener

Your retirement plan might seem an unlikely battleground for fighting global warming. But it may be a promising one.

So maintains Sam Gooch, a program manager at Waymo, a unit of Alphabet GOOG. Late last year, Gooch, 39, attended a lecture at Alphabet by the environmentalist Bill McKibben, who has been warning people about the impact global warming would have on their retirement investments.

Google, Alphabet’s largest unit, had committed to achieving net zero emissions across its businesses by 2030 by advancing carbon-free energy. Yet Google’s retirement plan was stuffed with exposure to the fossil fuel providers that play a central role in warming the planet.

“That for me was the aha moment,” says Gooch. That was when he began organizing fellow employees to get Google to offer climate-friendly options in its retirement plan.

Your 401(k) Plan Is Vulnerable to Climate Risk

It’s a view that investors, large and small, are starting to agree with.

Why? For many people, a retirement plan represents their single-largest financial investment. But the manifestations of climate change—such as extreme heat, water insecurity, wildfires, and floods—present risks that could destabilize the global economy and that investment. In turn, lack of attention to those hazards puts employers (and the money managers they hire) at risk.

Says Michael Frerichs, the Illinois State Treasurer, which oversees some investment plans: “This isn’t about pushing personal values. It’s about pushing value for plan participants.”

Still, many plan participants are also looking to align their values with their investments, including those entering the work force today. It’s particularly true for younger investors. Sustainable investing has been one way to do it, particularly because it addresses a range of societal challenges by considering environmental, social, and governance risk and the opportunities that arise from mitigating those risks.

According to a Morgan Stanley Institute for Sustainable Investing survey, 77% of individual investors are interested in investing in companies or funds that aim to achieve market-rate financial returns while also considering positive social and/or environmental impact. Some 57% say their interest has increased in the last two years, partly due to new climate science findings. And a large majority of millennials, or people born between the early 1980s and 1996, say they are interested in pursuing sustainable investments for their retirement plans.

How to Invest Sustainably Through Your Retirement Plan

So how to do it? It’s not that easy—but there are ways.

Fewer than 15% of 401(k) plans offer an ESG fund in their investment lineup, according to research by Jane Danyu Zhang, assistant professor of finance, University of Oregon Lundquist College of Business. Zhang also found that plans were more likely to offer an ESG option if they were in politically liberal jurisdictions. And note that many ESG funds still own fossil fuel producers, although they may carry lower risk than their peers.

Why do so few offer an ESG fund? Employers, also known as the retirement “plan sponsor,” have been wary because stances toward ESG have changed with political winds.

• The Trump administration said companies could only consider “pecuniary” factors, or factors related to money, when considering what funds to include in their plans.
• The Biden administration ruled that ESG factors could be considered but only as a “tiebreaker” between two funds with similar performance or other pecuniary measure.

Partly as a result, sustainably-invested assets in retirement plans are minimal, which also leads plan sponsors to infer that they’re unpopular.

Meanwhile, less than a third of retirement plans offer a so-called brokerage window, which allows one to open a self-directed brokerage account that lives within their retirement plan and own a wider range of investments. Big companies are more likely to have them, according to the Plan Sponsor Council of America.

Still, “at the end of the day, employers are fiduciaries,” says Alex Wright-Gladstein, founder of Sphere, which offers a fossil-fuel-free index fund and other climate-friendly retirement options. They will pay attention.

11 Tips on Investing Sustainably Through Your Retirement Plan

All that said, here are a few guidelines.

1. Don’t put all your money into the single ESG fund on offer. Make sure it fits your asset allocation. For example, my Morningstar plan offers me Vanguard FTSE Social Index VFTNX, which excludes energy companies as well as various companies operating in controversial businesses. It has a Morningstar Medalist Rating of Silver. But it doesn’t help me with exposure to smaller companies or fixed income.

2. If you do open a self-directed brokerage account in your retirement plan, research your options. Make sure you can dedicate time to managing your investments. For most of us, retirement plans are set-and-forget, which is why target-date funds are so popular. Still, depending on your plan, you may be able to work with a financial advisor, a robo-advisor, or use various investment models on offer.

3. Look to replicate your existing asset allocation. Depending on your employer, you might be able to invest in one of the available sustainable target-date funds, such as Fidelity Sustainable Target Date 2045 Fund FSYHX or BlackRock LifePath ESG Index 2040 Fund LEKKX.

Sam Adams, CEO of Vert Asset Management and co-author of Your Essential Guide to Sustainable Investing, recommends doing a “search and replace” to green your assets. “You’re still buying bread and milk and cucumbers, but you’re buying the organic option,” says Adams. “But do it where you can, and don’t change your asset allocation too much to get more sustainability. When I go to the grocery store, I try to buy organic, but if organic eggs aren’t available, I’m not coming without eggs.” You may have to take a bond fund that’s less sustainable than you like, for example. But “go whole hog,” says Adams. After all, the plan isn’t taxable, and the older you get, the greater the climate risk. (You can see Adams’ portfolio in this chart.)

4. Allocate to thematic funds sparingly. If you plan to dabble in thematic investing—a clean tech fund, say—advisors typically recommend confining yourself to just 5% of assets.

5. Avail yourself of free research tools. Morningstar’s sustainable-investing page contains lists of sustainable actively managed and index funds. Or if you have a specific fund in mind, look at the Sustainability tab on the fund’s Morningstar Quote page. The Risk section shows the fund’s Morningstar Sustainability Rating: Anything with 4 or 5 globes has below-average risk. The Values tab shows how the fund ranks versus its peers on its involvement with such themes as coal power or tobacco.

Christine Benz, Morningstar’s director of personal finance, has created a series of exchange-traded fund model portfolios geared toward people saving for retirement, including one with ESG-friendly investments.

Invest Your Values, offered by the investor advocate As You Sow, rates more than 50 retirement plans for investments in fossil fuels, deforestation, weapons, private prisons, and more. You can type in your fund or ETF into another As You Sow site—Fossil Free Funds—to see what percentage is invested in fossil fuels. Sphere’s AtmoSphere tool shows you how much money your retirement plan has invested in fossil fuel producers. (For Morningstar employees, it’s $81 million.)

6. Above all, avoid all the common 401(k) investing mistakes. Here’s a primer about how to set up your 401(k). And here are common mistakes and how to avoid them. And you can always check in with Morningstar’s page on 401(k) plans.

What If Those Options Aren’t Available in Your 401(k) Plan?

7. Get active. Research your company’s 401(k) or other retirement plan, and then approach the retirement plan committee for your company—your colleagues who serve as fiduciaries for your plan and help choose the fund options—to ask for sustainable options. Go through the benefits of doing so. Focus on the financial reasons for avoiding fossil fuels. Explain that adding sustainable options increases savings rates, a win-win metric for employers who sponsor the retirement plan and employees who invest in it. For example, a 2021 Schroders study found that nine out of 10 participants who were aware their defined-contribution plan had sustainable-investing options invested in them. Of those who didn’t know if their plan offered ESG investment options, 69% said they would or might increase their overall contribution rate if they were offered ESG options.

8. Frame ESG and climate-friendly options as additional options, rather than an attempt to force all employees to invest sustainably. Here’s a handy guide to how to approach your employer by Zach Stein, author of “The Ultimate Guide to Sustainable Investing” and cofounder of the Carbon Collective, which offers climate-friendly 401(k) plans. “If portfolios don’t take [ESG or climate risk] into account, they’re not adequately preparing for the future” and opening up plan sponsors to future litigation, Stein says. That said, understand that your employer won’t agree immediately.

9. Push for a climate-friendly 401(k) target-date fund, or default option. A single ESG fund is too “random,” says Stein. For example, Carbon Collective offers four lineups: Conventional Passive, Active ESG, Passive ESG, and Climate. The climate lineup includes Carbon Collective’s own ClimateSmart target-date option, Sphere 500 Climate Fund SPFFX, and Calvert Green Bond CGBIX. Target-date options will grow more important, as auto enrollment gains popularity. “Many default options capture 50% to 70% of assets in the plan,” says Andrew Montes of As You Sow.

10. Be clear about your expectations. “Investors think they’re going to save polar bears or the planet,” says Adams. “I don’t think I’m saving a polar bear when I recycle my Diet Coke can. But I want to be contributing to systemic change. When you’re an investor and you’re looking for more plan options, you’re sending a strong signal and it forces plan sponsors to start contributing more solutions.”

11. Organize your colleagues, as Waymo’s Gooch did. You won’t be the first one with these ideas. And collective action is more powerful than individual action.

Gooch and other employees began collecting signatures for a petition. Google already offered two sustainable funds in its plan: Parnassus Core Equity Investor PRBLX and Nuveen Large Cap Responsible Equity TISCX. What they wanted was a 401(k) that excludes companies that own fossil fuel reserves in thermal coal, oil, or gas, including in target-date funds. “We’re really trying to draw a bright line between ESG and a climate-safe portfolio,” Gooch says.

They collected more than a thousand signatures. They collaborated with shareholder advocate As You Sow for a campaign. With his colleagues Sam Asher and Emily Masten, Gooch penned a piece in the San Francisco Chronicle. The piece asserted that Google’s retirement plan owned more than $2 billion in fossil fuel investments through Vanguard target-date funds. It also said US workers as a whole own one fifth of US fossil fuel stocks through their 401(k)s.

They also proposed to Alphabet shareholders that the company study the risks from its retirement plan’s fossil fuel holdings. The proposal read:

“Shareholders request Alphabet publish a report disclosing how the Company is protecting plan beneficiaries—especially those with a longer investment time horizon—from increased future portfolio risk created by present-day investments in high-carbon companies.”

A handful of similar proposals at companies including Netflix NFLX and Microsoft MSFT have been filed over the past two years, according to Morningstar Sustainalytics.

Ultimately, just 9% of Alphabet shareholders voted in favor at the company’s annual meeting. Of course, voting rights are controlled by Google founders Larry Page and Sergey Brin. And Alphabet argued that 401(k) plan participants are already free to invest in a wide range of investments, including through the self-directed brokerage option, and that the proposal put “undue pressure on the fiduciary to make decisions that are not in the best interests of the participants.”

Still, Gooch holds out hope. Right now, the plan’s investment committee is considering the proposal to add options.

“You sign up for your 401(k) the first week at your job, when you have a ton of things to do and you forget to do something about it,” he says. “We want a target-date option that’s fossil fuel free. We want the company to make people have a green option and make people think about it for a few moments.”

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This article was first published on Morningstar here.