Over 80% of Americans are worried about climate change, but until very recently, everyone investing through a company 401(k) plan has been forced to invest in the fossil fuel industry. As impact investing becomes more prevalent, you may be wondering how to offer your employees a sustainable 401(k) option.
WHAT IS A FOSSIL-FREE 401(K) OPTION?
Fossil-free investing means avoiding giving your money to the biggest polluters in the world: companies whose main lines of business are in extracting, processing or burning fossil fuels like coal, oil and gas. These companies aren’t just contributing to climate change and polluting our natural world, but they plan to continue. Exxon, the United States’ biggest fossil fuel producer, has only pledged to cut CO2 emissions by 15-20% by 2025, which is far below what is needed to limit global warming to 1.5°C.
By refusing to invest in these companies, we send them a message: stop lobbying against climate legislation that keeps us safe and start participating in the conversation about what a world that does not exceed 1.5°C of warming should look like.
Previously there were a few issues preventing fossil-free options from showing up in 401(k) plans:
- Many fossil-free funds are expensive, and employers are often sued by their employees for having funds that are too expensive in their 401(k) plans;
- Many of the big 401(k) platforms don’t allow exchange traded funds (ETFs);
- The US Government has given mixed policy guidance to employers on whether they can put values-aligned investment options in 401(k)s.
We created Sphere to solve these issues.
The Sphere 500 Climate Fund (SPFFX) is priced in line with similar funds that track the top 500 US companies. Because we don’t charge a markup for removing fossil fuel companies, employers don’t need to worry about excessive fee lawsuits with this option. It is set up as a mutual fund, not an ETF, so it’s allowed on 401(k) platforms. And it has a simple strategy of investing in the top 500 US companies and removing the 40 or so fossil fuel companies in that list, resulting in a still-diversified portfolio that has only about 5% of the total market capitalization of the top 500 group removed. The cherry on top? Over the long-term investment horizons that are appropriate for retirement planning, studies have shown that removing fossil fuel companies either has no impact on investment returns or actually increases returns. In the 10-year backtest of our index, we found that this improved performance was true when applied specifically to the top 500 US companies.
And what about US government guidance on ESG (Environmental, Social, Governance) funds in 401(k)s? While guidance has varied across different presidential administrations on how to treat values-aligned investing in employer-sponsored retirement plans, one piece of guidance that has not changed is that fund performance matters. Employers have a responsibility to choose funds that perform well, and they should use financial performance measures in deciding what funds to include in their fund lineups. Given that removing fossil fuel companies in the past has improved long-term returns, employers can justify adding fossil-free funds to their menus based on performance alone, without having to touch on values-based reasoning in the decision-making process. While it is good news that the Biden administration is making it easier to invest in ESG retirement options, with a proposed bill that Senator Tina Smith summarised saying “Sustainable investment options are good for retirees and good for our environment - that’s a win-win,” the new legislation is not required for employers to have legal footing to add fossil-free options to their plans.
WHY SHOULD I INTRODUCE A FOSSIL FUEL-FREE 401(K) OPTION?
There are 3 reasons you should consider adding a fossil-free option to your 401(k) portfolio:
- To improve employee retention and recruiting
- To ensure your sustainability strategy does not have gaps
- To create good financial outcomes for your plan beneficiaries
Reason 1: Give your employees what they want, improving retention and recruiting
Employees of all ages, but especially younger ones, care deeply about environmental and social issues and want their workplaces to reflect that. Introducing a 401(k) option that lets employees invest aligned with their values shows that you care about what they want, without imposing a large cost to your organization or forcing anything on employees.
Millennials and Gen Zers make up half of the workforce, and will make up 75% of the workforce by 2030. A Cone Communications study found that 64% of them will not take a job at a company that does not have a strong corporate social responsibility (CSR) policy, and 83% would be more loyal to a company that helps them contribute to social and environmental issues. More than 10% of millennial workers in a Fast Company survey said they would be willing to take a $5,000-10,000 pay cut to work for a company that is environmentally responsible.
Gen Z has even stronger views. A study by WeSpire found that they are “the first generation to prioritize purpose over salary. They will leave companies they believe are hiding or putting too much spin on bad news, ignoring their negative environmental or social impacts, or that have toxic workplace cultures.”
The average tenure of an employee is now shorter than ever. In 2018, the median number of years salaried workers had been with their current employers was 4.2, and the pandemic has made this number go down. A 2021 report from the Bridge Group found average tenure to be as low as 1.8 years. Record-breaking numbers of employee resignations in the past few months have led to what is now being discussed as The Great Resignation, with workers quitting their jobs to find positions with better benefits, among other perks. This trend will likely continue, with 1 in 4 workers planning to look for a new job after the pandemic.
Replacing employees is not only time consuming for your HR team, but the average cost of replacing an employee can range from 50% to 200% of their annual salary. Turnover also has a massive impact across the company. Large amounts of departures and arrivals can influence team morale and increase workload on remaining employees, as well as result in inefficient teams and loss of key knowledge and skills. While salary is still the biggest factor in choosing a new job, culture is a close second. 30% of millennials said they’ve left a job because of a company’s lack of a sustainability plan.
Having a fossil free 401(k) option can help recruit employees who are leaving their jobs to find more sustainable companies. The statistics show high demand for quality jobs at companies with clear sustainability strategies, even if sustainability isn’t the main goal of the business.
Reason 2: Ensure your sustainability strategy does not have gaps
Lots of companies are doing their part to fight climate change by creating sustainability strategies such as targeting net zero carbon footprints or increasing workforce diversity. 90% of executives think sustainability is important and over 60% have already started to implement sustainability strategies. Companies like Nike, Ford, Starbucks and Google have comprehensive sustainability strategies, often led by a combination of senior leaders and everyday employees.
Investors and investment firms are often pushing for this change. The Climate Action 100+ initiative brings together 615 asset managers to engage with the world’s largest greenhouse gas emitting companies. BlackRock, which manages almost $7 trillion USD, joined the Climate Action group in 2020 after announcing “We believe evidence of the impact of climate risk on investment portfolios is building rapidly and we are accelerating our engagement with companies on this critical issue”.
You and your company may already have or be developing a sustainability strategy, or you may be thinking about introducing one. Introducing a fossil-free 401(k) option can be a great component at any stage of the process. If you’ve already implemented a strategy, introducing a sustainable 401(k) option can help employees engage on a personal level. If you’re just getting started, adding a 401(k) option can be a low-overhead way of demonstrating commitment to your employees.
Reason 3: Create good financial outcomes for your employees
While we’ve discussed the benefits of giving your employees a 401(k) option that is aligned with their values, we can’t forget the main reason for offering employees a 401(k). A good 401(k) plan is one of the main ways employers can help employees save for retirement.
The best bet for a financially stable future is a diversified portfolio that does not take unnecessary risks on individual companies or industries. But several studies [here, here and here] have shown that funds that are not invested in fossil fuel companies perform as well as or, in many cases, better than funds that are invested in fossil fuel companies.
Retirement saving by its very nature is long-term, and many investors see fossil fuel companies as bad long-term investments. Energy companies currently risk wasting over $1.6 trillion USD of investment by assuming that no regulations will be introduced to reduce carbon emissions, which seems optimistic given increasing international efforts for global legislation, including just a few months ago at COP26.
On top of this, the fossil fuel industry has been volatile in the past, with both massive booms and busts. If it remains volatile when employees reach retirement age, their savings could be hit hard by downswings.
By giving employees the option to invest their retirement savings in a fossil-free fund, you allow them to align their investments with their values, while feeling comfortable that you’re offering a good financial option.
HOW DO I GET BUY-IN AT MY COMPANY?
While the benefits are clear, you may worry about getting this idea past senior leadership. To prepare, outline why this makes sense for your company and how you would implement it. Here at Sphere, we’d be happy to help you with either of these - just give us an email or a phone call.
Most senior leaders will want to see the business case. We’re happy to help you look at metrics and data to show the impact this would have on employee satisfaction at your company.
For a case study of an organization that has already implemented a fossil-free 401(k) option, read our interview with Marco Merz, Head of the defined contribution plan at the University of California. We discuss what motivated them to introduce a fossil-free option to their 300,000 plan participants and how the change happened.
WHAT SHOULD I DO NEXT?
Contact us - we’d love to share more about the Sphere offerings.
If you would like to do more research, our website has more information on impact and other relevant topics. Here are some additional resources for you to have a look at:
- Fossil-Free Funds: A non-profit website dedicated to increasing transparency in retirement savings. You can search for any mutual fund or ETF and see how well it performs on a number of sustainability metrics.
- How to Save a Planet: A climate podcast with clear action items at the end of each episode. They have covered impact investing.
- “Socially Responsible Investing For Retirement”, Forbes: This article dives into the various elements of impact investing in retirement savings.
- “How to Get Socially Conscious Funds into Your 401(k)”, The New York Times. A good how-to guide on how to persuade your company to introduce an impact investing option to your 401(k).
